Problem: Nevada Inc. is a fast-growing corporation. Analysts project the followi

Question

Problem: Nevada Inc. is a fast-growing corporation. Analysts project the following free cash flows (FCFs) during the next three years, after which FCF is expected to grow at a constant rate of 5%. Firm's WACC is 11%. Year FCF (S million) 20 11 17 45 FirmValueoWACC g Free Cash Flow a) What is firm's horizon, or continuing, value? b) What is the firm's value today (Firm Valuco) c) Suppose firm has $112.60 million of debt and 25 million shares of stock outstanding. What is your estimate of the current price per share? Given the current market price of stock is $100, how a rational and risk-averse investor would invest this stock? What is the firm's value in year 1 (FirmValue) d) e)

Explanation / Answer

Ans1. Since the growth of the company in a long run is constant, to calculate the terminal value we will use the constant growth model.

Terminal value = FV(in last year)/(K-G)

Putting the values in the formula 45*(1+5%)/(11%-5%)=$787.5

B. The firm value is calcuated Free Cashflow/WACC-G

To calculate free cashflow we will discount all the cashflows to the current year, whcih is the year 0.

The present value of each cashflow will be = Free cashflow year n/(1+WACC)^n

Note: We will add the terminal value to the cashflow of the third year and discount it back. Also, here the value is calculated taking the formula provided. Otherwise the cashflow should have been discounted by WACC only

C. To calculate per share price we will subtract the value of the firm with the debt, to get the equity shareholder value, and then will devide the value with number of outstanding shares.

D. Given the current stock price is $100 the rational investor would sell the shares becuase fundamentally it is showing that the stock is over valued ($24.5). And there is a high chance the market will recognise it, and the prices will slump.

E. The firms value in year 1 is

This is calculated adjusting the discounting of the future cashflows beyond year 1.  

Year 0 1 2 3 WACC 11% FCF ($ millions) 20 -11 17 45 Growth 5% Terminal Value 787.5

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