Question

Quantitative Problem 2: Hadley Inc. forecasts the year-end free cash flows (in millions) shown below. 5 Year 1 2 3 4 FCF -$22.74 $37.1 $43.1 $52.3 $55.3 The weighted average cost of capital is 12%, and the FCFs are expected to continue growing at a 5% rate after Year 5. The firm has $25 million of market value debt, but it has no preferred stock or any other outstanding claims. There are 18 million shares outstanding. Also, the firm has zero non operating assets. What is the value of the stock price today (Year 07 Round your answer to the nearest cent. Do not round Intermediate calculations. per share According to the valuation models developed in this chapter, the value that an investor assigns to a share of stock is dependent on the length of time the investor plans to hold the stock. The statement above is -Select- Conclusions $ Analysts use both the discounted dividend model and the corporate valuation model when valuing mature, dividend paying firms; and they generally use the corporate model when valuing divisions and firms that do not pay dividends. In principle, we should find the same intrinsic value using either model, but differences are often observed. Even if a company is paying steady dividends, much can be learned from the corporate model; so analysts today use it for all types of valuations. The process of projecting future financial statements can reveal a great deal about a company's operations and financing needs. Also, such an analysis can provide insights into actions that might be taken to increase the company's value; and for this reason, it is integral to the planning and forecasting process.

Answer 1

Horizon value at Year5=FCF6/(cost of capital-growth rate)

FCF6=FCF5*(1+growth rate)=$55.3*(1+5%)=$58.065 million

Horizon value=$58.065/(12%-5%)=$829.5 million

Value of the Firm=(FCF1/(1+12%))+(FCF2/(1+12%)^2)+(FCF3/(1+12%)^3)+(FCF4/(1+12%)^4)+((FCF5+Horizon value at year5/(1+12%)^5)

=(-22.74/1.12)+(37.1/1.12^2)+(43.1/1.12^3)+(52.3/1.12^4)+(884.8/1.12^5)

=-20.30+29.58+30.68+33.24+502.06

=$575.25 million

Value of the equity=value of the firm-value of debt=$575.25-$25=$550.25 million

Value of share=Value of the equity/Shares outstanding=550.25/18=$30.57

2. The statement is wrong. The value of stock depends on the future expected cashflows to the equity shareholder's but not on the length of time the investor holds the stock