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Ted Corporation expects to generate free-cash flows of $200,000 per year for the next five years. Beyond that time, free cash flows are expected to grow at a constant rate of 5 percent per year forever. If the firms average cost of capital is 15 percent, the market value of the firms debt is $500,000, and Nico has a half million shares of stock outstanding, what is the value of Ted stock?

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Karabo99

Answer:

The value of Ted stock is $2.43

Explanation:

Free cash flow From Year 1 to 5 = $200000

Cash Flow Year 6 = 200000*1.05

                              = $210000

This cash flow is expected to grow forever, so the terminal value can be caluclated at Year 5 of the above perptuity by Gordon Growth model

Terminal Cash FLow Value at Year 5 = 210000/(15% - 5%)

                                                              = $2100000

Present Value of above stream

= 200000*PVIFA(5 yr, 15%) + 2100000*PVIF(5 yr, 15%)

= $200000*3.352 + $2100000*0.497

= $1714100  

Value of equity = Present Value of Firm - Value of debt

                          = $1714100 - $500000

                          = $1214100  

Number of shares = 500000

Value per share = $1214100/500000

                           = $2.43

Therefore, The value of Ted stock is $2.43

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