Mike Company\'s free cash flow is $1.75 million. Its free cash flow growth rate
ID: 2778587 • Letter: M
Question
Mike Company's free cash flow is $1.75 million. Its free cash flow growth rate is expected to be constant at 25% for 2 years, after which free cash flows are expected to grow at a rate of 6% forever. Its weighted average cost of capital WACC is 12%. Huxley has $5 million in short-term investments and $7 million in debt and has 1 million shares outstanding. What is the best estimate of the current intrinsic stock price?
a.
$40.64
b.
$44.92
c.
$41.71
d.
$39.58
e.
$42.64
a.
$40.64
b.
$44.92
c.
$41.71
d.
$39.58
e.
$42.64
Explanation / Answer
Calculation of current intrinsic stock price:
Year 0
Year 1
Year 2
Year 3
Free Cash Flows
$ 2.18750
$ 2.73438
$ 2.89844
(1.75*125%)
(2.1875*125%)
(2.734375*106%)
Terminal Value at the end of year 2
$ 48.30729
= Year 3 Free cash Flows / (WACC - Growth rate)
2.8984375 / (12%-6%)
Net Cash Flows (CF)
$ 2.18750
$ 51.04167
PVF (12%)
0.89286
0.79719
PV = CF*PVF
$ 1.95
$ 40.69
Current intrinsic stock price = CF * PVF
$ 42.64
Calculation of current intrinsic stock price:
Year 0
Year 1
Year 2
Year 3
Free Cash Flows
$ 2.18750
$ 2.73438
$ 2.89844
(1.75*125%)
(2.1875*125%)
(2.734375*106%)
Terminal Value at the end of year 2
$ 48.30729
= Year 3 Free cash Flows / (WACC - Growth rate)
2.8984375 / (12%-6%)
Net Cash Flows (CF)
$ 2.18750
$ 51.04167
PVF (12%)
0.89286
0.79719
PV = CF*PVF
$ 1.95
$ 40.69
Current intrinsic stock price = CF * PVF
$ 42.64