Covan, Inc. is expected to have the following free cash flow: 2 3 4 FCF 12 14 15
ID: 2794828 • Letter: C
Question
Covan, Inc. is expected to have the following free cash flow: 2 3 4 FCF 12 14 15 16 Grow by 5% per year a. Covan has 6 million shares outstanding, $3 million in excess cash, and it has no debt. If its cost of capital is 11%, what should be its stock price? b. Covan reinvests all its FCF and has no plans to add debt or change its cash holdings (it does not invest its cash holdings). If you plan to sell Covan at the beginning of year 2, what is its expected price? c. Assume you bought Covan stock at the beginning of year 1. What is your expected return from holding Covan stock until year 2? a. Covan has 6 million shares outstanding, $3 million in excess cash, and it has no debt. If its cost of capital is 11%, what should be its stock price? The stock price should be $. (Round to the nearest cent.) b. Covan reinvests all its FCF and has no plans to add debt or change its cash holdings (it does not invest its cash holdings). If you plan to sell Covan at the beginning of year 2, what is its expected price? If you plan to sell Covan at the beginning of year 2, its price should be S(Round to the nearest cent.) c. Assume you bought Covan stock at the beginning of year 1. What is your expected return from holding Covan stock until year 2? 2Explanation / Answer
Terminal Value in year 4, TV4 = FCF4 x (1 + g) / (r - g) = 16 x (1 + 5%) / (11% - 5%) = $280 million
Value of firm = FCF1 / (1 + r) + FCF2 / (1 + r)^2 + FCF3 / (1 + r)^3 + (FCF4 + TV4) / (1 + r)^4
= 12 / 1.11 + 14/1.11^2 + 15/1.11^3 + (16 + 280)/1.11^4
= $228.13
Stock Price, P0 = (Firm Value + Cash - Debt) / No. of shares = (228.13 + 3) / 6 = $38.52
b) After two years, Stock price = P0 x (1 + r)^2 = 38.52 x 1.11^2 = $47.46
c) Expected return = cost of capital = 11%