Max Hype Inc. is expected to have an EBIT of $440,000.00 next year. Also next year,...

Max Hype Inc. is expected to have an EBIT of $440,000.00 next year. Also next year, depreciation, the increase in net working capital, and capital spending are expected to be $37,500.00, $23,000.00, and $47,500.00, respectively. All of these variables are expected to grow at 7 percent per year until the end of year 5. The company currently has $120,000.00 in debt and 450,000 shares outstanding. After Year 5, the adjusted cash flow from assets is expected to grow at 4 percent indefinitely. The company's WACC is 9 percent and its tax rate is 35 percent.

What is the price per share of the company's stock?
If the company's stock price is $14.01 on the stock market, is the company overvalued, undervalued or correctly priced on the stock market?
Would you buy the company's stock? Why or why not?

Expert Solution

Answer a.

Expected FCF, FCF1 = EBIT * (1 - tax) + Depreciation - Increase in NWC - Capital Spending
Expected FCF, FCF1 = $440,000 * (1 - 0.35) + $37,500 - $23,000 - $47,500
Expected FCF, FCF1 = $253,000

Growth rate for next 4 years is 7% and a constant growth rate (g) of 4%

FCF2 = $253,000 * 1.07 = $270,710
FCF3 = $270,710 * 1.07 = $289,660
FCF4 = $289,660 * 1.07 = $309,936
FCF5 = $309,936 * 1.07 = $331,632
FCF6 = $331,632 * 1.04 = $344,897

WACC = 9%

Horizon Value = FCF6 / (WACC - g)
Horizon Value = $344,897 / (0.09 - 0.04)
Horizon Value = $6,897,940

Value of Firm = $253,000/1.09 + $270,710/1.09^2 + $289,660/1.09^3 + $309,936/1.09^4 + $331,632/1.09^5 + $6,897,940/1.09^5
Value of Firm = $5,601,924

Value of Equity = Value of Firm - Value of Debt
Value of Equity = $5,601,924 - $120,000
Value of Equity = $5,481,924

Share Price = Value of Equity / Shares Outstanding
Share Price = $5,481,924 / 450,000
Share Price = $12.18

Answer b.

Current price is higher than the intrinsic value of stock. So, the stock is overvalued.

Answer c.

You should not purchase the stock as it is overvalued.

jeff jeffy answered 9 months ago

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