Question

Brees Industries is considering going public but is unsure of a fair offering price for the company. Before hiring an investment banker to assist in making the public offering, managers at Brees have decided to make their own estimate of the firm’s common stock value. The firm’s CFO has gathered data for performing the valuating using the free cash flow valuation model. The firm’s weighted average cost of capital is 10%, and it has $800,000 of debt at market value and $600,000 of preferred stock at its assumed market value. The estimated free cash flows over the next 4 year, 2020 through 2023, are given below. Beyond 2017 to infinity, the firm expects its free cash flow to grow by 3% annually.
2020 RM 100000
2021 RM 200000
2022 RM 310000
2023 RM 450000

A) estimate the value of the entire company using the free cash flow valuation model?

b) using finding in part a, find the common stock value?

c) if the firm plan to issue 100,000 shares of common stock, what is the estimated value per share?

Answer 1

a) First we calculate terminal value of the firm after 2023.

terminal value = cash flow 2023*(1+growth rate)/(weighted average cost of capital(WACC) - growth rate)

terminal value = 450000*(1+0.03)/(0.10 - 0.03) = 450,000*1.03/0.07 = 463,500/0.07 = 6,621,428.57

Value of company = Cash flow 2020/(1+WACC)¹ + Cash flow 2021/(1+WACC)² + Cash flow 2022/(1+WACC)³ + (cash flow 2023 + terminal value)(1+WACC)⁴

Value of company = 100,000/(1+0.10) + 200,000/(1+0.10)² + 310,000/(1+0.10)³ + (450,000+6,621,428.57)/(1+0.10)⁴

Value of company = 100,000/1.10 + 200,000/1.21 + 310,000/1.331 + 7,071,428.57/1.4641 = 90,909.09 + 165,289.26 + 232,907.59 + 4,829,880.86 = 5,318,986.80

value of the entire company using the free cash flow valuation model is $5,318,986.80.

b) Common stock value = company value - market value of debt - market value of preferred stock

Common stock value = 5,318,986.80 - 800,000 - 600,000 = $3,918,986.80

c) estimated value per share = Common stock value/no. of common stock shares = $3,918,986.80/100,000 = $39.19 per share