Question

River Enterprises has ​$505 million in debt and 22 million shares of equity outstanding. Its excess cash reserves are $14 million. They are expected to generate ​$190 million in free cash flows next year with a growth rate of 2​% per year in perpetuity. River​ Enterprises' cost of equity capital is 13​%. After analyzing the​ company, you believe that the growth rate should be 3​% instead of 2​%. How much higher​ (in dollars) would the price per share be if you are​ right

Answer 1

Answer:

$7.85

Explanation:

the firm's total value = $190,000,000 / (13% - 2%) = $1,727,272,727

equity = $1,727,272,727 - $505,000,000 (debt) = $1,222,272,727

price per stock = $1,222,272,727 / 22,000,000 = $55.56 per stock

if you are right and the firm's growth rate is 3%, then:

the firm's total value = $190,000,000 / (13% - 3%) = $1,900,000,000

equity = $1,900,000,000 - $505,000,000 (debt) = $1,395,000,000

price per stock = $1,395,000,000 / 22,000,000 = $63.41 per stock

the difference = $63.41 - $55.56 = $7.85 or 14.13%