Question

Covan, Inc. is expected to have the following free cash? flow:

Year 1 2 3 4

FCF 13 15 16 17 Grow by 3 % per year

a. Covan has 6 million shares? outstanding, ?$3 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? Your expected return from holding Covan stock until the beginning of year 2 is (?%)?

Answer 1

Year		Free Cash flow	PV factor	PV of all dividends
1		13.00	0.909	11.82
2		15.00	0.826	12.40
3		16.00	0.751	12.02
4		17.00	0.683	11.61
4		250.14	0.683	170.85
			Total PV	218.70
Current Free cash flow	17.0000
Rate of return	10.00%
Growth Rate	3%
Present value of all dividends til infinity at year 2
	=Current OCF*(1+Growth rate)/(Rate of return-Growth Rate)
	= 17*(1+0.03)/(0.10-0.03)
	250.14
PV of future cash flow	218.70
Current cash	3
Total PV of cash	221.70
No of shares	6
Share price today	=221.70/6	36.95
Solution B
Year		Free Cash flow	PV factor	PV of all dividends
1		15.00	0.909	13.64
2		16.00	0.826	13.22
3		17.00	0.751	12.77
3		250.14	0.751	187.94
			Total PV	227.57
Cash value	=3*(1+10%)
	3.3
PV of future cash flow	227.57
FV of excess cash at Y0	3.3
PV of cash received at y1	13
Total	243.87
No of shares	6
share price at Y1	=243.87/6	40.645
Solution C
Return	=40.645-36.95	3.695
Percentage return=	=3.695/36.95	10%