WITH EXPLANATION PLEASE Long Island Power and Light\'s free cash flow next year
ID: 2620969 • Letter: W
Question
WITH EXPLANATION PLEASE
Long Island Power and Light's free cash flow next year will be $100 million and it is widely expected to grow at a 5 percent annual rate indefinitely. The company's weighted average cost of capital is 10 percent, the market value of its liabilities is $1 billion, and it has 20 million shares outstanding
a. Estimate the price per share of Long Island’s common stock.
b. A private equity firm believes that by selling the company’s 767 airplane, increasing the work day to eight hours, and instituting other cost savings, it can increase Long Island’s free cash flow next year to $110 million and can add a full percentage point to Long Island’s growth rate without affecting its cost of capital. What is the maximum price per share the private equity firm can justify bidding for control of LONG ISLAND.
Explanation / Answer
a. total value of the firm = 100/(0.10 - 0.05) = 2000 million
value of equity = 2000 - 1000 million = 1000 million
price per share = 1000/20 = 50
b. total value of the firm = 110/(0.10 - 0.06) = 2500 million
value of equity = 2500 - 1000 = 1500 million
price per share = 1500/20 = 75
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