Question

An analyst is trying to estimate the intrinsic value of Burress Inc. The analyst has estimated the company's free cash flows for the following years

Year Free Cash flow

1 $3,000

2 $4,000

3 $5,000

An analyst estimates that after 3 years (t=3) the company's cashflows will grow at a constant rate of 6% per year. the analyst estimates that the company's WACC is 10%. the company's debt and preferred stock has a total market value of $25,000 and there are 1,000 outstanding shares of common stock. If the price of the stock is currently $80 per share, will you invest in it?

Answer 1

Horizon value at year 3 = CF3(1+g)/(WACC-g)

                       = 5000(1+.06)/(.10-.06)

                       = 5000 * 1.06 / .04

                        = $ 132500

PRESENT VALUE OF FIRM =[PVF10%,1*CF1]+[PVF10%,2*CF2]+[PVF10%,3*CF3]+[PVF10%,3*HORIZON VALUE]

            =[.90909*3000]+ [.82645*4000]+[.75131*5000]+[.75131*132500]

           = 2727.27+ 3305.8+ 3756.55+ 99548.58

           = $ 109338.20

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

                   = 109338.20 - 25000

                 = 84338.20

Fair value of common stock per share = 84338.20/1000 = $ 84.34 per share

since the fair value of share is higher than actual price of $ 80 per share ,you should invest in this stock .