Question

Your employer, a mid-sized human resources management company, is considering expan- sion into related fields, including the acquisition of Temp Force Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporary heavy workloads. Your employer is also considering the purchase of Bigger staff & McDonald (B&M), a privately held company owned by two friends, each with 5 million shares of stock. B&M currently has free cash flow of $24 million, which is expected to grow at a constant rate of 5%. B&M's financial statements report short-term investments of $100 million, debt of $200 million, and preferred stock of $50 million. B&M's weighted average cost of capital (WACC) is 11%. Answer the following questions. a. Describe briefly the legal rights and privileges of common stockholders. b. What is free cash flow (FCF)? What is the weighted average cost of capital? What is the free cash flow valuation model? c. Use a pie chart to illustrate the sources that comprise a hypothetical company's total value. Using another pie chart, show the claims on a company's value. How is equity a residual claim? d. Suppose the free cash flow at Time 1 is expected to grow at a constant rate of g forever. If gi < WACC, what is a formula for the present value of expected free cash flows when discounted at the WACC? If the most recent free cash flow is expected to grow at a constant rate of g forever (and g < WACC), what is a formula for the present value of expected free cash flows when discounted at the WACC? e. Use B&M's data and the free cash flow valuation model to answer the following

Answer 1

a. Legal rights and privilages of common stockholders.
Individuals that own common share of company are viwed as the true owners of that company. All common share holders have the right to participate in acompany's profit for as long as they owns the shares. Common stock holders can aslo influence a compasnys management by their voting right. and if the company issue new shares to public current share holder have the right to buy shares before they are offered.

b. What is free cash flow (FCF)? What is weighted average cost of capital? What is the free cahs flow valuation model?
Free cash flow is the cash a company produces through its operation, less the cost of expenditure on assetes. In other words, free cash flow refers to the cash available after meating all the expences, taxes and capital expenditure.
Free cash flow (FCF)= Operating cash flow - Capital expenditures.
Weighted average cost of capital is the rate that a company is expected to pay average to all its security holders. In other words it refers to the minimum required rate of which a company should earn, this is the least rate of return which a company sholud earn for its survival.
Free cash flow valuation model is when growth rate is constant for forever current year free cash flow * (1+growth rate/ WACC-growth)

c. As here we dont have any option to draw a pie chart I'm giving the example in writing
bonds 500000
common stock 4000000
preferred stock 250000
retained earning 250000
total market value 5000000

Debt 10%
equity 90%
total 100%

Debt 500000 (10%)
equity 4500000 (90%)
total 5000000
Equity is a residual claim because dividend isdistributed after the fixed financial commitments and also in thecase of liquidation they get payment is last.

d. Terminal value stock= expected free cashflow/ WACC-growth rat
Present value of free cash flow= expected free cash flow/ (1+r)^2+terminal value/(1+r)
Present value of free cash flow= current free cashflow* (1+r)/(1+r)^1+ rerminal value/(1+r)