Question

purchase of Biggerstaff & 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 state- ments 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 g, < 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? i bib dW e. Use B&M's data and the free cash flow valuation model to answer the following questions: (1) What is its estimated value of operations? (2) What is its estimated total corporate value? (This is the entity value.) (3) What is its estimated intrinsic value of equity? (4) What is its estimated intrinsic stock price per share? f. You have just learned that B&M has undertaken a major expansion that will change noile

Case: Mini Case - Temp Force, (end of Chapter 7). Respond to Questions a, b, d, and e (1, 2, 3, 4). Please answer with never used answers. Thanks

Answer 1

a> The rights and privileges that common stakeholders have:

The Right to Influence Management

Common shareholders also have the right to influence company management through the election of a company's board of directors. In smaller companies, the president or chairperson of the board is typically the individual who owns the largest share of common stock. Larger companies may have greater diversity in the common shareholder investor pool.

In either case, individuals in the management of the company do not own enough of a stake in the company to influence who sits on the board of directors. Shareholders have the right to influence who holds management positions through control over the election of board members.

The Right to Buy New Shares

Common shareholders also have preemptive rights. If the company issues new shares to the public, current shareholders have the right to buy a specific number of shares before the stock is offered to new potential shareholders. Preemptive rights can be valuable to common shareholders, as they are often provided at a subscribed price on a per-share basis.

The Right to Vote

Arguably, the greatest right for common shareholders is the ability to cast votes in a company's annual or general meeting. Major shifts within a publicly-traded company must be voted on before changes can take place, and common shareholders hold the right to vote either in person or via proxy. Most common shareholder voting rights equate to one vote per share owned, resulting in greater influence from shareholders who own a larger number of shares.

The Right to Sue for Wrongful Acts

Common shareholders who feel their rights have been violated also have the right to sue the issuing company. A court has the power to enforce common shareholder rights when corporations are found to have violated their rights, either through a single shareholder complaint or as a class-action lawsuit.

b> Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.

Interest payments are excluded from the generally accepted definition of free cash flow. Investment bankers and analysts who need to evaluate a company’s expected performance with different capital structures will use variations of free cash flow like free cash flow for the firm and free cash flow to equity, which are adjusted for interest payments and borrowings.

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capital. Importantly, it is dictated by the external market and not by management. The WACC represents the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere.

Free Cash Flow Valuation

In free cash flow valuation, intrinsic value of a company equals the present value of its free cash flow, the net cash flow left over for distribution to stockholders and debt-holders in each period.

There are two approaches to valuation using free cash flow. The first involves discounting projected free cash flow to firm (FCFF) at the weighted average cost of the capital (WACC) to find a company's total value (i.e. sum of its equity and debt). The second involves discounting the free cash flow to equity (FCFE) at the cost of equity to find the value of the company's shareholders equity.