Question

Question 2 A company is expected to generate free cashflows of $60 million next year, projected to grow at a 5% annual rate until the end of year 3, and then at a stable 2% rate in perpetuity thereafter. You estimate that the company's cost of capital is 11%. It has $250 million debt and $15 million cash. Number of shares outstanding is 10 million. How much would you be willing to pay for each share? Round to the nearest cent.

Answer 1

Given for a company,

Next year Free cash flow, FCFF1 = $60 million
growth rate is 5% until end of year 3

So, FCFF2 = FCFF1*1.05 = 60*1.05 = $63 million

FCFF3 = FCFF2*1.05 = 63*1.05 = $66.15 million

There after, grwoth rate g = 2%

cost of capital Kc = 11%

So, firm value at year 3 using constant growth model is

EV3 = FCFF3*(1+g)/(Kc-g) = 66.15*1.02/(0.11 - 0.02) = $749.70 million

Firm value today is PV of future FCFF and EV3 discounted at Kc

EV0 = FCFF1/(1+Kc) + FCFF2/(1+Kc)^2 + FCFF3/(1+Kc)^3 + EV3/(1+Kc)^3

EV0 = 60/1.11 + 63/1.11^2 + 66.15/1.11^3 + 749.7/1.11^3 = $701.73 million

We know that,

Firm value = MV of debt + MV of equity - cash

So, 701.73 = 250 + MV of equity - 15

=> MV of equity = $466.73 million

MV of equity = number of shares outstanding*current share price

So, 466.73 = 10*P0

=> P0 = $46.67

Stock price today is nearly, $46.67