Question

Problem 9-19
Corporate valuation

Barrett Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Barrett does not pay any dividends, and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Barrett's stock. The pension fund manager has estimated Barrett's free cash flows for the next 4 years as follows: $2 million, $6 million, $11 million, and $13 million. After the fourth year, free cash flow is projected to grow at a constant 8%. Barrett's WACC is 16%, the market value of its debt and preferred stock totals $52 million, and it has 16 million shares of common stock outstanding.

a. What is the present value of the free cash flows projected during the next 4 years? Round your answer to the nearest cent.

b. What is the firm's horizon, or continuing, value? Round your answer to the nearest cent.

c. What is the firm's total value today? Round your answer to the nearest cent.

d. What is an estimate of Barrett's price per share? Round your answer to the nearest cent.

Answer 1

a.

Free cash flow in year 4 = $13 million.

Constant growth rate = 8%

Horizon value = $13 × (1 + 8%) / (16% - 8%)

= $14.04 / 8%

= $175.50 million.

Horizon value is $175.50 million.

b.

Present value of the free cash flows projected during the next 4 years and Value of firm today is calculated in excel and screen shot provided below:

Present value of the free cash flows projected during the next 4 years is $20.41 million.

Value of firm is $117.34.

d.

Value of equity = Value of firm - Value of debt and preferred stock

= $117.34 - $52

= $65.34 million.

Value of equity is $65.34 million.

Intrinsic value of stock = Value of equity / Number of share outstanding

= $65.34 million / 16

= $4.08

Intrinsic value of stock is $4.08.