Corporate valuation Barrett Industries invests a large sum of money in R&D; as a
ID: 2740827 • Letter: C
Question
Corporate valuation Barrett Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Barrett does not pay any dividends, and it has no plans to pay dividends in the near future major pension fund is interested in purchasing Barrett's stock. The pension fund manager has estimated Barrett's free cash flows for the next 4 years as follows: $2 million, $5 million, $11 million, and $15 million. After the fourth year, free cash flow is projected to grow at a constant 8%. Barrett's WACC is 11%, the market value of its debt and preferred stock totals $56 million, and it has 19 million shares of common stock outstanding. Write out your answers completely. For example, 13 million should be entered as 13, 000,000. What is the present value of the free cash flows projected during the next 4 years? Round your answer to the nearest cent. What is the firm's horizon, or continuing, value? Round your answer to the nearest cent. What is the firm's total value today? Round your answer to the nearest cent. What is an estimate of Barrett's price per share? Round your answer to the nearest cent.Explanation / Answer
1)
years
Free cash flows
PV factor @11%
present value
0
1
1
2000000
0.900900901
1801801.802
2
5000000
0.811622433
4058112.166
3
11000000
0.731191381
8043105.194
4
15000000
0.658730974
9880964.612
23783983.77
2.
Horizon value (At the end of year 4) = Free cash flows at the end of year 5 / (Cost of capital - Growth rate of cash flows)
Free cash flows at the end of year 5 = Cash flows at the end of year 4 * (1 + Growth rate)
= $ 15,000,000 * (1 +8%)
= $ 16,200,000
Horizon value = $ 16,200,000 / (11% - 8%)
= 540,000,000
3. Total value of firm = Value of preferred stock and debt + Value of common stock
Value of common stock = PV of free cash flows (for first 4 years) + PV of horizon value (at the end of 4 years)
= $ 23,783,983.77+ ($ 540,000,000 / ((1+11%) ^4)).. Values taken from part 1 and 2 of the question
= $ 23783983.77+355,714,726
= $ 379,498,710
Thus, total value of firm = Value of preferred stock and debt + Value of common stock
= $56,000,000 + $379,498,710
= $ 435,498,710
4. Barrett’s price per share = Value of common stock / No. of shares of common stock outstanding
= $ 435,498,710/ 19,000,000
= $ 22.921
years
Free cash flows
PV factor @11%
present value
0
1
1
2000000
0.900900901
1801801.802
2
5000000
0.811622433
4058112.166
3
11000000
0.731191381
8043105.194
4
15000000
0.658730974
9880964.612
23783983.77