Question

Maxwells Hammers is a start up, fast growing supplier of hand tools. The expected free cash flows for the next three years is:

Year 1 ($20,000,000)

Year 2 $30,000,000

Year 3 $40,000,000

It then expects to grow at a constant rate of 7% and its WACC is 13%. Maxwell has $100,000,000 of debt and 10,000,000 shares outstanding

-What is the is the expected per share value of the stock today?

-If the current market price was $50 per share, would you buy it or short it?

-If the current market price was $40 per share, would you buy it or short it?

Answer 1

Part A:

Value of firm = PV of FCFs

Valueof firm after 3 Years = FCF4 / [ WACC - g ]

FCF4 = FCF3 ( 1 + g )

= $ 40000000 ( 1 + 0.07 )

=$ 40000000 *1.07

= $ 42800000

Valueof firm after 3 Years = FCF4 / [ WACC - g ]

= $ 42800000 / [ 13% - 7% ]

= $ 42800000 / 6%

= $ 713,333,333.33

value of firm Today :

Year	FCF	PVF @13%	PV of FCFs
1	$ (20,000,000.00)	0.8850	$ (17,699,115.04)
2	$   30,000,000.00	0.7831	$   23,494,400.50
3	$   40,000,000.00	0.6931	$   27,722,006.49
3	$ 713,333,333.33	0.6931	$ 494,375,782.42
Value of firm			$527,893,074.37

Share price = [ Value of firm - Debt ] / No. of shares

= [ $ 527893074.37 - $ 100000000 ] / 10 M

= $ 427893074.37 / 10 M

= $ 42.79

Part B:

If Market Price ( $ 50) > fair Price ($ 42.79) , Stock is over Priced and adviced to short sell.

Part C:

If Market Price ( $ 40) < fair Price ($ 42.79) , Stock is under Priced and adviced to Buy the same.