Question

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.

1. What is the price per share of the company's stock?
2. 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?
3. Would you buy the company's stock? Why or why not?

Answer 1

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.