Question

2. Corporate valuation model

Flying Cow Aviation Inc.’s free cash flows (FCFs) are expected to grow at a constant long-term growth rate (gLgL) of 16% per year into the future. Next year, the company expects to generate a free cash flow of $7,000,000. The market value of Flying Cow’s outstanding debt and preferred stock is $45,000,000 and $25,000,000, respectively. Flying Cow has 1,500,000 shares of common stock outstanding, and its weighted average cost of capital (WACC) is 23%.

Given the preceding information, complete the adjacent table (rounding each value to the nearest whole dollar), and assuming that the firm has not had any nonoperating assets in its balance sheet.

Term	Value
Value of Operations
Value of Firm’s Common Equity
Value of Common Stock (per share)

Oops, a more careful review of Flying Cow’s balance sheet actually reports a $2,480,000 portfolio of marketable securities. How does this new information affect the intrinsic value of Flying Cow’s common equity (expressed on a per-share basis) assuming no other changes to the Flying Cow financial situation? Review the statements below and select those that accurately describe Flying Cow’s financial situation. Check all that apply.

The greater the market value of the marketable securities portfolio, the smaller the company’s total intrinsic (entity) value.

The intrinsic value of Flying Cow’s common stock increases with the inclusion of the company’s marketable securities portfolio into the analysis.

The intrinsic value of Flying Cow’s common stock decreases with the inclusion of the company’s marketable securities portfolio into the analysis.

The intrinsic value of the company’s common stock isn’t affected by the new information.

Answer 1

Present value of growing perpetuity = first payment / (discount rate - growth rate)

Value of Operations = next year FCF / (WACC - growth rate)

Value of Operations = $7,000,000 / (23% - 16%)

Value of Operations = $100,000,000

Value of Firm’s Common Equity = Value of Operations - debt - preferred stock

Value of Firm’s Common Equity = $100,000,000 - $45,000,000 - $25,000,000

Value of Firm’s Common Equity = $30,000,000

Value of Common Stock (per share) = Value of Firm’s Common Equity / shares outstanding

Value of Common Stock (per share) = $30,000,000 / 1,500,000

Value of Common Stock (per share) = $20.00

Valuation after including marketable securities

Value of Firm’s Common Equity = Value of Operations - debt - preferred stock + marketable securities

Value of Firm’s Common Equity = $100,000,000 - $45,000,000 - $25,000,000 + $2,480,000

Value of Firm’s Common Equity = $32,480,000

Value of Common Stock (per share) = Value of Firm’s Common Equity / shares outstanding

Value of Common Stock (per share) = $32,480,000 / 1,500,000

Value of Common Stock (per share) = $21.65

The second statement applies. All the other statements are incorrect. This is because with the inclusion of marketable securities, the intrinsic value per share has increased