Question

1. Bird Song Industries makes a bird seed that sets native song birds singing all day long. Its product has been discovered by the back-to-nature crowd around the world. As a result, Bird Song's executives expect free cash flow (FCF) to grow rapidly over the next 3 years. The forecast FCFs are 25 in 2020 (one year from now), 40 in 2021, with a jump to 80 in 2022. After 2022 Bird Song expects growth to slow to 2.5% per year in perpetuity. Bird Song's weighted average cost-of-capital (WACC) is 11%.   What is Bird Song’s fundamental value?

Answer 1

The fundamental value of Bird song can be calculated in two parts. first, calculate and sum the present values of first 3 cash flows. The formula to calculate present value of a cash flow is:

Where

• C is the cash flow
• r is the rate of return (WACC in this case)
• n is the period in which the cash flow happens

So, the PV of first 3 cash flows is:

.......(1)

Next step is to calculate the present value of perpetuity which starts from year 4 onwards. The formula to calculate present value of a perpetuity is:

Where

• Where g is the constant growth rate

Substituting the given we get the present value of this perpetuity as:

Now, the value of this perpetuity is as at period 3. This is because the first cash flow of this perpetuity happens in period 4. Therefore, this PV has to be discounted further to period zero by using the cash flow discounting equation. This is as shown:

........(2)

Now, the fundamental value of the company is equation (1) + (2) which is equal to 818.86 (113.48+705.38)