It is January 2015. You work as a financial analyst for Merck & Co. and are task

Question

It is January 2015. You work as a financial analyst for Merck & Co. and are tasked with the due diligence on the proposed acquisition of a biotech startup. You estimated the following cash flows for the startup: Year Expected free cash flow to the firm ($ million) (end of year) 2015 87 2016 130.5 2017 169.65 2018 203.58 2019 223.94 After 2019, free cash flows are expected to grow by 3% per year. Based on the riskiness of your industry, you think that your weighted average cost of capital is 12%. The biotech firm has 5 million shares and bonds worth $120 million outstanding.

a) What is the terminal value, i.e., the present value of all free cash flows from 2020 to infinity expressed in 2019-dollars (in $ million)?

b) What is the total value of the company (in $ million)?

c) What is the value per share of common stock (in $)?

Explanation / Answer

a) Terminal value:

=Free cash flow to firm in Year6/(K-g)

k=cost of capital

g=growth rate

=(223.94*(1+.03))/(0.12-0.09)

=$2562.87 mn

b)

Tota value of company:

=87/(1+.12)^1+130.5/(1+.12)^2+169.65/(1+.12)^3+203.58/(1+.12)^4+223.94/(1+.12)^5+ 2562.87/(1+.12)^5

=$2013.15 mn

c)Value per share:

Remove debt valuefrom the total company value

=2013.15-120=$1893.15mn

value per share=1893.15/5

=$378.63 per share

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