Question

Brandtly Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Brandtly does not pay any dividends, and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Brandtly's stock. The pension fund manager has estimated Brandtly's free cash flows for the next 4 years as follows: $2 million, $6 million, $8 million, and $15 million. After the fourth year, free cash flow is projected to grow at a constant 7%. Brandtly's WACC is 9%, the market value of its debt and preferred stock totals $54 million; and it has 12 million shares of common stock outstanding.

Write out your answers completely. For example, 13 million should be entered as 13,000,000.

1. What is the present value of the free cash flows projected during the next 4 years? Round your answer to the nearest cent. Do not round your intermediate calculations.
   
   $
2. 
   
3. What is the firm's horizon, or continuing, value? Round your answer to the nearest cent.
   
   $
4. 
   
5. What is the firm's total value today? Round your answer to the nearest cent. Do not round your intermediate calculations.
   
   $
6. 
   
7. What is an estimate of Brandtly's price per share? Round your answer to the nearest cent. Do not round your intermediate calculations

Answer 1

a. What is the present value of the free cash flows projected during the next 4 years?

Estimated Brandtly's free cash flows for the next 4 years as follows:

FCF1 =$2 million

FCF2= $6 million

FCF3= $8 million

FCF4= $15 million

The discount rate Brandtly Industries is WACC = 9%, therefore present value of these cash flows are as follows –

PV of FCF1 = FCF1/ (1+ WACC) ^1 = $2,000,000 / (1+ 9%) ^1 = $1,834,862.39

PV of FCE2 = FCF2/ (1+ WACC) ^2 = $6,000,000 / (1+ 9%) ^2 = $5,050,079.96

PV of FCE3 = FCF3/ (1+ WACC) ^3 = $8,000,000 / (1+ 9%) ^3 = $6,177,467.84

PV of FCE3 = FCF4/ (1+ WACC) ^4 = $15,000,000 / (1+ 9%) ^4 = $10,626,378.17

Total = $1,834,862.39 + $5,050,079.96 + $6,177,467.84 + $10,626,378.17

= $23,688,788.35

b. What is the firm's horizon, or continuing, value?

Horizon value in the terminal year

Formula for terminal cash flow calculation

Terminal cash flows = FCF4 * (1+g %) / (WACC% - g %)

The constant growth rate g =7% for forever after year 4

Therefore,

Terminal cash flows = $15,000,000 * (1+7%)/ (9%-7%)

= $802,500,000.00

Now you have to discount the terminal cash flow also to the present value to get the Horizon value

Horizon value = Terminal cash flow / (1+ WACC) ^11

= $802,500,000.00/ (1+9%) ^4

= $568,511,231.88

c. What is the firm's total value today?

Firm's total value today = the present value of the free cash flows projected during the next 4 years + Horizon value

= $23,688,788.35 +$568,511,231.88

= $592,200,020.23

d. What is an estimate of Brandtly's price per share?

Brandtly's price per share =Firm’s value to equity shareholders/ Number of common stock outstanding

= (Firm's total value today - the market value of its debt and preferred stock) / number of common stock outstanding

= ($592,200,020.23 - $54,000,000)/ 12,000,000

= $538,200,020.23/12,000,000

=$44.85

Therefore Brandtly's price per share is estimated to be $44.85.