Question 2: A firm will make $5 in free cash flow next year and $8 in...
Question 2: A firm will make $5 in free cash flow next year and $8 in free cash flow two years from now. Then the firm’s free cash flow is expected to grow by 2% forever. The discount rate for the firm’s equity is 10%. What is a fair stock price for the firm?
Question 3: You look up the firm from Question 3 above’s stock price quote on Yahoo! Finance and see the firm is trading at $96.73. Will you even consider buying the firm’s stock based on this?
Homework Answers
2)
value of stock = Present value of CFC + Horizontal value
Horizontal value = FCF next year/(Required return - growth rate)
=>
horizontal value =8 *1.02/(0.1-0.02)
= 102
value of stock = 5/1.1 + 8/1.1^2 + 102/1.1^2
= 95.46
3)
No, since stock price is over valued
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