Question

Brandtly Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Brandtly does not pay any dividends, and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Brandtly’s stock. The pension fund manager has estimated Brandtly’s free cash flows for the next 4 years as follows: $3 million, $6 million, $8 million, and $16 million. After the fourth year, free cash flow is projected to grow at a constant 3%. Brandtly’s WACC is 9%, the market value of its debt and preferred stock totals $75 million; and it has 7.5 million shares of common stock outstanding. a. What is the present value of the free cash flows projected during the next 4 years? b. What is the firm’s horizon, or continuing, value? c. What is the firm’s total value today? d. What is an estimate of Brandtly’s price per share?

Answer 1

Answer:

a. What is the present value of the free cash flows projected during the next 4 years?

the NPV of the firm's cash flows = $3/1.09 + $6/1.09² + $8/1.09³ + $16/1.09⁴ = $2,752,294 + $5,050,080 + $6,177,468 + $11,334,803 = $25,314,645

b. What is the firm’s horizon, or continuing, value?

to calculate terminal or horizon value at year 4, we must use the Gordon growth model formula:

terminal value = [$16,000,000 (1 + 3%)] / (9% - 3%) = $16,480,000 / 6% = $274,666,667

c. What is the firm’s total value today?

firm's total present value = $25,314,645 + ($274,666,667/1.09⁴) = $219,895,463

d. What is an estimate of Brandtly’s price per share?

Brandtly's share price = (firm's present value - total debt) / outstanding stocks = ($219,895,463 - $75,000,000) / 7,500,000 million stocks = $19.32 per stock