The Gray Furniture Co earned $4.00 per share last year. Investment in fixed capi

Question

The Gray Furniture Co earned $4.00 per share last year. Investment in fixed capital was $2.25 per share, depreciation was $1.60, and the investment in working capital was $0.40 per share. Gray is currently operating at its target debt-to-asset ratio of 40%. Thus 40% of annual investments in working capital and fixed capital will be financed with new borrowings. Shareholders require a return of 15% on their investment and the expected growth rate is 4%. The value of Gray's stock is closest to $29.86 $30.86 $31.86 $32.86

Explanation / Answer

Gray's FCFE = Net Income - (1 - Debt) * (Fixed Capital - Depreciation + Working capital)

Gray's FCFE = 4 - (1 - 0.40) * (2.25 - 1.60 + 0.40)

Gray's FCFE = 4 - 0.63

Gray's FCFE = $3.37

Gray's Stock Price = FCFE * (1+g) / required rate - growth rate

Gray's Stock Price = 3.37 * (1+0.04) / 0.15 - 0.04

Gray's Stock Price = 3.5048 / 0.15 - 0.04

Gray's Stock Price = $31.86 Option C

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