Question

After year 3, free cash flows are expected to grow at a constant 5% a year indefinitely. The discount rate is 10%. The firm has debt of $50 million, cash of $20 million and has 10,000,000 shares outstanding. What is the price of the stock

Answer 1

The price of the stock = $26.69

Step-by-step explanation:

Missing question at inception is as follows "A firm expects the following free cash flows: Year 1: $10 million, Year 2: $12 million, Year 3: $15 million"

Year Cash-flows"million D. rate at 10% Discounted cash flows

1 10 0.9091 9.0910

2 12 0.8264 9.9168

3 15 0.7513 11.2695

4 315 0. 7513 236.6595

Total $266.9368

The price of the stock = Total Present value of cash flows / Number of Shares outstanding

The price of the stock = $266,936,800 / 10,000,000 shares

The price of the stock = $26.69368

The price of the stock = $26.69

Thus, the price of the stock is $26.69 per share

Note:

Present value of future cash flows at year 3 = 15*(1.05/10%-5%) = 15*(1.05/5%) = 15 * 21 = $315 million

Discount rate for each year = 1/(1+r)^1 = 1/(1+0.10)^1 = 1/1.10 = 0.90909