Question

You are trying to value the stock of MicroTrans Inc. using a free cash flow model. The firm currently has 75 million shares outstanding, a market value of debt of $300 million and $80 million in excess cash. You have estimated the free cash flows for the next few years as shown in the table below. You also assume that free cash flows will grow at a rate of 3% each year after year 3 (in perpetuity). The weighted average cost of capital (WACC) is 10%. Given this information, what is the best estimate for the share price of MicroTrans? Select one.

Free Cash Flow Forecasts (in $-million)
Year	1	2	3
Free Cash Flow (in $-million)	200	220	230

	I.	$37.05
	II.	$28.95
	III.	$38.12
	IV.	$25.07
	V.	$41.05

Answer 1

Free cash flow for year 1 to 3 has been provided

- Caculating the Horizon Value at year end 3:-

where, FCF3 = Free Cash flow in year 3 = $230 million

g = Growth rate of FCF beyond year 3 = 3%

WACC = 10%

Horizon Value at year end 3 = $3384.2857 million

- Calculating the Enterprise Value ($ millions):-

EV = 181.818 + 181.818 + 172.802 + 2542.664

EV = $3079.1027 millions

- Enterprise Value = Market Value of equity + Market Value of Debt - Cash & Cash equivalents

$3079.1027 millions = Market Value of equity + $300 million - $80 million

Market Value of equity= $2859.1027 million

- Price per share = Market Value of equity/No of shares outstanding

= $2859.1027 million/75 million

Price per share = $38.12

So,the best estimate for the share price of MicroTrans is $38.12

Option III.

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