Question

Plane Industries is expected to generate the free cash flows over the next four years (listed below), after which they are expected to grow at a rate of 5% per year. Cash flows are in millions of dollars. If the weighted average cost of capital is 12% and Plane Industries has cash of $65 million, debt of $45 million, and 30 million shares outstanding, what is Plane company's expected current share price?

Cash Flow by year

year 1: $14

year 2: $20

year 3: $22

year 4: $26

A.10.95

B. 15.10

C. 16.54

D. 12.61

Answer 1

Given about Plane industries,

Cash flows are as follow:

CF1 = $14

CF2 = $20

CF3 = $22

CF4 = $26

thereafter, growth rate g = 5%

Cost of capital K = 12%

So, value of firm in year 4 is calculated using constant growth model:

V4 = CF4*(1+g)/(K-g) = 26*1.05/(0.12-0.05) = $390

So, Enterprise value today is

EV = CF1/(1+K) + CF2/(1+K)^2 + CF3/(1+K)^3 + (CF4+V4)/(1+k)^4

=> EV = 14/1.12 + 20/1.12^2 + 22/1.12^3 + (390+26)/1.12^4 = $308.4786 million

Cash = $65 million

Debt = $45 million

Number of shares = 30 million

So, Value of stock today is (EV + Cash - Debt)/Shares = (308.4786 + 65 - 45)/30 = $10.95

So, option A is correct.