Question

You are considering buying common stock in Grow On, Inc. You have calculated that the firm's free cash flow was $8.00 million last year. You project that free cash flow will grow at a rate of 7.0% per year indefinitely. The firm currently has outstanding debt and preferred stock with a total market value of $13.88 million. The firm has 1.36 million shares of common stock outstanding. If the firm's cost of capital is 21.0%, what is the most you should pay per share for the stock now?

Answer 1

Answer:

The most that should be paid today for 1 share of stock is $34.75

Explanation:

Using the FCFF approach, we can calculate the Value of the firm and can use it to determine the value of the equity.

The value of equity provided by FCFF and FCFE can be used to determine the price per share or fair value per share by dividing the total value of equity by the number of outstanding common shares.

The value of equity = Value of firm - market value of debt

For a firm whose FCFF is growing at a constant rate forever, the formula for the Present value of the firm is,

Value of the Firm (Vf)= FCFF0 * (1+g)  /  (WACC - g)

Where WACC is the cost of capital.

Vf = 8 * (1+0.07)  /  (0.21 - 0.07)

Vf = 61.14285714 million

Value of equity = 61.14285714 - 13.88 = $47.26285714 million

Fair value per share = Value of equity / Number of share outstanding

The fair value per share = 47.26285714 / 1.36   = $34.75 per share