Question

Qui Enterprises forecasts the free cash flows (in millions) shown below (*Year 1 - Year 5.)

The weighted average cost of capital is 13.0%, and the FCFs are expected to continue growing at a 5% rate after Year 5.

The company’s balance sheet shows $10 million of notes payable, $50 million of long-term debt, $25 million of preferred stock, $18 million of retained earnings, and $80 million of total common equity.

Q. a. If the company has 5 million shares of stock outstanding, a. what is the best estimate of its price per share?

Q. b. Based on the answer from (a), if the market price of the stock is observed to be $30 per share, should you buy or sell the stock? Explain.

*FCF Year 1: $10, Year 2 $15, Year 3 $20, Year 4 $25, Year 5 $28

Answer 1

Value of company is Present Value of free cash flows and terminal value generated by Company.          
Terminal value at end of year 5= FCF of year 5*(1+ perpetual growth rate)/(wacc - growth rate)          
28*(1+5%)/(13%-5%)          
367.5          
          
PV of cash flows = Cash flows *PVF          
PVF = 1/(1+wacc)^n          
n = year          
          
Calcultion of Value of Firm          
          
Year   FCF   PVF@11%   PVF*FCF
1   10   0.8849557522   8.849557522
2   15   0.7831466834   11.74720025
3   20   0.6930501623   13.86100325
4   25   0.6133187277   15.33296819
5   28   0.542759936   15.19727821
5   367.5   0.542759936   199.4642765
          
          
Total value of firm           264.4522839
          
          
Value of Equity = Value of Firm -notes payable - Long term debt - preferred           
264.4522839   -10-50-25      
179.4522839          
Price per share = VALUE OF EQUITY/number of shares          
179.4522839   /5      
35.89045678          
          
So best estimate of price is    $35.89      
          
Stock price is $30          
So it is worth buying          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
          
   is
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