Question

Consider the case of Merry Meerkat Marketing Inc.:

Merry Meerkat Marketing Inc. is expected to generate a free cash flow (FCF) of $825,000 this year, and the FCF is expected to grow at a rate of 14% over the following two years (FCF2 and FCF3). After the third year, however, the company’s FCFs are expected to grow at a constant rate of 6% per year, which will last forever (FCF4 - ∞). If Merry Meerkat’s weighted average cost of capital (WACC) is 12%, complete the following table and compute the current value of Merry Meerkat’s operations. Round all dollar amounts to the nearest whole dollar, and assume that the firm does not have any nonoperating assets in its balance sheet and that all FCFs occur at the end of each year.

Year	CFtt	PV(FCFt)
FCF1	$825,000
FCF2
FCF3
FCF4
Horizon Value4- ∞
	Vop =

Merry Meerkat’s debt has a market value of $11,798,866, and Merry Meerkat has no preferred stock in its capital structure. If Merry Meerkat has 250,000 shares of common stock outstanding, then the total value of the company’s common equity is_____________, and the estimated intrinsic value per share of its common stock is _________ per share.

Assume the following:

•	The end of Year 3 differentiates Merry Meerkat’s short-term and long-term FCFs.
•	Professionally-conducted studies have shown that more than 80% of the average company’s share price is attributable to long-term—rather than short-term—cash flows.

Is the percentage of Merry Meerkat’s expected long-term cash flows consistent with the value cited in the professional studies?

A. No, because only 50.05% of the firm’s share price is derived from its expected long-term free cash flows.

B. Yes, because 85.70% of the firm’s share price is derived from its expected long-term free cash flows.

C. Yes, because 75.42% of the firm’s share price is derived from its expected long-term free cash flows.

D. No, because the percentage of Merry Meerkat’s expected long-term cash flows is actually 14.30%.

Answer 1

There are different conventions for horizon value. Hence, providing two tables -the only difference in the table is the horizon value

or

Merry Meerkat’s debt has a market value of $11,798,866, and Merry Meerkat has no preferred stock in its capital structure. If Merry Meerkat has 250,000 shares of common stock outstanding, then the total value of the company’s common equity is =15731824-11798866=3932958.000, and the estimated intrinsic value per share of its common stock is =3932958.000/250000=15.732 per share.

B. Yes, because 85.70% of the firm’s share price is derived from its expected long-term free cash flows.