Question

West Fraser Timber Company (WFT) is expected to have free cash flow in the coming year of $2 million and its free cash flow is expected maintain at a sustainable growth rate of 4% per year. It has a debt worth $10 million. It’s equity cost of capital is 12%, cost of debt before tax is 6%, and it pays a corporate tax rate of 30%. If WFT Company maintains a debt-equity ratio of 0.5 and the company has 3 million common shares outstanding, what is the fair value of WFT stock?

Answer 1

Hi

Here Free cash flow CF= $2,000,000

Growth rate g= 4%,

Debt d= $10,000,000

Cost of debt kd = 6% or 0.06

Equity cost of capital ke= 12% or 0.12

Tax rate t= 30% or 0.30

Debt equity ratio d/e= 0.5

$10,000,000 / e = 0.5

e = $10,000,000 / 0.5

e = $20,000,000

WACC = (Debt / (Equity + Debt) * Cost of debt * (1 - tax rate)) + (Equity / (Equity + Debt) * Cost of equity))

WACC = ($10 million/($20 million + $10 million) * 0.06 * (1 - 0.30)) + ($20 million / $20 million + $10 million) * 0.12

WACC = (0.3333 * 0.06 * 0.70) + (0.6667 * 0.12)

WACC = 0.0140 + 0.080 = 0.094 or 9.4%

As per perpetuity model

Value of WFT = Expected free cash flows / (WACC - Growth rate)

Here,

Expected free cash flows = $2 million

WACC = 0.094

Growth rate = 4% or 0.04

Value of WFT = $2 million / (0.094 - 0.04)

Value of WFT = $37.04 million

Fair value of stock = Value of WFT / Outstanding common shares

Here,

Value of WFT = $37.04 million

Outstanding common shares = 3 million shares

Now,

Fair value of stock =$37.04 million/3 million shares

Fair value of WFT stock = $12.35 per share

Thanks