Barrett Industries invests a lot of money in R&D, and as a result it retains and

Question

Barrett Industries invests a lot of money in R&D, and as a result it retains and reinvests all of its earnings. In other words, Barrett does not pay any dividends, and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Barrett's stock. The pension fund manager has estimated Barrett's free cash flows for the next 4 years as follows: $2 million, $6 million, $10 million, and $14 million. After the 4th year, free cash flow is projected to grow at a constant 8%. Barrett's WACC is 10%, its debt and preferred stock total to $18 million, and it has 12 million shares of common stock outstanding.

a. What is the present value of the free cash flows projected during the next 4 years? Round your answer to two decimal places at the end of the calculations. Enter your answer in millions. For example, an answer of $25,120,000 should be entered as $25.12.


b. What is the firm's terminal value? Round your answer to two decimal places at the end of the calculations. Enter your answer in millions. For example, an answer of $25,120,000 should be entered as $25.12.


c. What is the firm's total value today? Round your answer to two decimal places at the end of the calculations. Enter your answer in millions. For example, an answer of $25,120,000 should be entered as $25.12.


d. What is an estimate of Barrett's price per share? Round your answer to two decimal places at the end of the calculations.

Explanation / Answer

a. PV of cash flows for first 4 years = 1.82+4.96+7.51+9.56 = 23.85 b. Cash Flow at the end of year 5 = 14*1.08 = 15.12 since g = 8% & Re = 10%. Therefore, Terminal Value = 15.12/ (.10-.08) = 756 PV of this terminal value = 516.36 c. Firm's total value today = (a) + (b) = 23.85 + 516.36 = 540.21 d. Total value of equity = 540.21 - 18 = 522.21 No. of shares = 12 Therefore, value per share = 522.21/12 = 43.52.

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