Question

John Smith, an analyst with Fidelity Securities, is trying to evaluate Company ABC’s target stock price per share. Free cash flow (FCF) estimates for the next four years are -$2, $15, 17, and $20 million, after which the FCF is expected to grow at 6% forever. The overall firm cost of capital is 9%. The firm has $45 million in debt and has 16 million shares of stock. What are the horizon value HV and the estimated value per share? Show your calculations

Answer 1

Required Return	9.00%
Growth after 4 years	6.00%
Step 1 - PV of free cash flow (in millions)
Year	Free cash flow	PV of FCF @ 9%
1	-$2.00	-$1.83
2	$15.00	$12.63
3	$17.00	$13.13
4	$20.00	$14.17
		$38.09
Step 2 - Calculation of Horizon Value(terminal value) (in millions)
`
FCF at the end of 5th year	=20*(1+.06)
		$21.20
Horizon(Terminal )Value                            =	FCF at the end of 5th year
		Required rate - Growth rate
	=	$21.20
		0.09-0.06
	=	$706.67
PV of Horizon Value(discounted today) =	706.67/(1+0.09)^4
=	=	$500.62
Value of Firm=	38.09+500.62
Value of Firm=	$538.71 million
Value of Equity = Value of Firm - Value of Debt = 538.71 - 45
Value of Equity = $493.71 million
Estimated Value per share = Value of Equity / Number of shares
Estimated Value per share = 493.71 / 16
Estimated Value per share = $30.86