Question

Barrett Industries invests a large sum of money in R & D; as a result, it retains and reinvests all of its earnings. In other words, Barrett does not pay any dividends and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Barrett's stock. The pension fund manager has estimated Barrett's free cash flows for the next four years as follows: $3 million, $6 million, $10 million, and $15 million. After the fourth year, free cash flow is projected to grow at a constant 7% Barrett's WACC is 12%, its debt and preferred stock total $60 million, and it has 10 million shares of common stock outstanding. Required: a) Determine Barrett's enterprise value b) Estimate Barrett's price per share of common stock.

Answer 1

Growth rate after 4 years = 7%
Cash flow for year 5 = $15,000,000*1.07 = $16,050,000
WACC = 12%
Value of free cash flows after year 4 at the end of 4 = $16,050,000 / (0.12-0.07)
= $16,050,000 / 0.05
= $321,000,000
Free cash flow for year 4 = $15,000,000+321,000,000 = $336,000,000
Year 1 2 3 4
Total free cash flow $3,000,000 $6,000,000 $10,000,000 $336,000,000
PVIF12% 0.8929 0.7972 0.7118 0.6355
PV of free cash flow $2,678,571 $4,783,163 $7,117,802 $213,534,074
PV $228,113,612

Enterprise value = Market capitalization - Cash and equivalents + Debt + Preferred stock
= $228,113,612 + 60,000,000 = $288,113,612