Question

Lance Inc.'s free cash flow was just $1.00 million. If the expected long-run growth rate for this company is 5.4%, if the weighted average cost of capital is 11.4%, Lance has $4 million in short-term investments and $3 million in debt, and 1 million shares outstanding, what is the intrinsic stock price?

Answer 1

Using the Gordon Growth Model and the information provided, after adjusting the free cash flow to equity and discounting the terminal value, the intrinsic stock price of Lance Inc. is calculated to be approximately $31.54 per share.

Step-by-step explanation:

To calculate the intrinsic stock price of Lance Inc., we'll use the Gordon Growth Model (a version of the Dividend Discount Model) which considers the free cash flow as a proxy for the dividends that could be paid to shareholders. This model calculates the present value of the expected future cash flows that grow at a constant rate.

Steps to calculate the intrinsic stock price:

1. Adjust the free cash flow to equity (FCFE) by adding short-term investments and subtracting the debt. FCFE = Free Cash Flow + Short-term investments - Debt.
2. Calculate the terminal value (TV) of the company using the Gordon Growth Model formula: TV = (FCFE × (1 + Growth Rate)) / (WACC - Growth Rate).
3. Calculate the market value of equity by discounting the terminal value to present value: Market Value of Equity = TV / (1 + WACC).
4. Divide the market value of equity by the number of shares outstanding to find the intrinsic stock price per share.

Using the information provided:

FCFE = $1.00 million + $4 million - $3 million = $2.00 million

TV = ($2.00 million × (1 + 0.054)) / (0.114 - 0.054) = $2.108 million / 0.06 = $35.13 million

Market Value of Equity = $35.13 million / (1 + 0.114) = $31.54 million (approx)

Intrinsic stock price per share = $31.54 million / 1 million shares = $31.54 per share

Answer 2

Value of cash flow for firm= FCFE*(1+G)/WACC-G

= 1,000,000*(1+0.054)/0.114-0.054

Firm Value=17,566,666

The value of equity is the value of the firm minus the value of debt:

17,566,666-3,000,000=14,566,666

14,566,666/1,000,000=14.5 per share

$14.5 is the intrinsic stock price

Step-by-step explanation: