Question

In: Finance

Year 1 2 3 4 grow by 3% per year••• FCF 1212 1414 1515 1616 Covan...

Year

1

2

3

4

grow by 3% per year•••

FCF

1212

1414

1515

1616

Covan has 6 million shares outstanding, $4 million in excess cash, and it has no debt. If its cost of capital is 10 % ,

what should be its stock price? b. Covan reinvests all its FCF and has no plans to add debt or change its cash holdings (it does not invest its cash holdings). If you plan to sell Covan at the beginning of year 2, what is its expected price? c. Assume you bought Covan stock at the beginning of year 1. What is your expected return from holding Covan stock until year 2?

Solutions

Expert Solution

(a) V0 = (1212/1.1) + (1414/1.12)+ (1515/1.13) + (1616/1.14) + {[1616*(1.03)/(0.1-0.03)] *(1/1.14) }

= 20753.29398 Million

Note:  [1616*(1.03)/(0.1-0.03)] is the terminal value calculated as FCF4*(1+g)/(r-g). You will note that we discounted it to 4 periods.

(Price/Share)t=0 = (FV - Debt + Cash)/(number of outsatnding shares) = (20753.29398 - 0+ 4)M/6M = 3459.548997

(b) V1 = (1414/1.1)+ (1515/1.12) + (1616/1.13) + {[1616*(1.03)/(0.1-0.03)] *(1/1.13) }

= 21616.62338 Million

Note:  [1616*(1.03)/(0.1-0.03)] is the terminal value calculated as FCF4*(1+g)/(r-g). You will note that we discounted it to 3 periods. V1 is such that we are standing at t=1 (beginning of year2).

(Price/Share)t=1 = (FV - Debt + Cash)/(number of outsatnding shares) = (21616.62338 - 0+ 4)M/6M = 3603.43723

(c) Holding Period Return for holding from t0 to t1 = (3603.43723 - 3459.548997)/3459.548997

=4.15916%


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