Question

J. Suppose Bon Temps embarked on an aggressive expansion that requires additional capital. Management decided to finance the expansion by borrowing $40 million and by halting dividend payments to increase retained earnings. Its WACC is now 7%, and the projected free cash flows for the next three years are -$5 million, $10 million, and $20 million. After Year 3, free cash flow is projected to grow at a constant 5%. What is Bon Temps’s total value? If it has 10 million shares of stock and $40 million of debt and preferred stock combined, what is the price per share?

K. Suppose Bon Temps decided to issue preferred stock that would pay an annual dividend of $5.00 and that the issue price was $100.00 per share. What would be the stock's expected return? Would the expected rate of return be the same if the preferred was a perpetual issue or if it had a 20-year maturity?

Answer 1

J.

WACC = 7% or 0.07

Growth rate (g) = 5% or 0.05

Free cash flow in one year (FCF₁) = -$5 million

Free cash flow in two years (FCF₂) = $10 million

Free cash flow in three years (FCF₃) = $20 million

Shares outstanding = 10 million shares

Debt and preferred stock = $40 million

Solution :-

K.

Given,

Annual dividend = $5

Issue price = $100

Solution :-