Saskatchewan River Enterprises (SRE) has
$700700
million in debt and
1010
million shares of equity outstanding. Its excess cash reserves are
$2525
million. SRE is expected to generate
$300300
million in free cash flows next year with a growth rate of 2% per year in perpetuity. SRE's cost of equity capital is
1212%.
a. What is SRE's stock price?
b. After analyzing the company, you believe that the growth rate should be 3% instead of 2%. Assume debt and cash values do not change. What should the stock price be, given the higher growth rate?
c. Given the growth rate change from 2% to 3%, how can you calculate the change in stock price without calculating the amounts in a or b above?
a) As per earnings growth model:
Value of Business = Value of future cash flows (1+g)/ ke-g
g = growth rate=2%
ke = Cost of equity=12.%
Value of business= $ 300(1+0.02)/0.12-002
=$ 3060 million
Value of share = Value of business/number of share
= 3060/25=$122.4 per share
b)
Value of Business = Value of future cash flows (1+g)/ ke-g
g = growth rate=3%
ke = Cost of equity=12.%
Value of business= $ 300(1+0.03)/0.12-003
=$ 3400 million
Value of share = Value of business/number of share
= 3400/25=$136 per share
Saskatchewan River Enterprises (SRE) has $700700 million in debt and 1010 million shares of equity outstanding....
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