Calvert Industries invests a large sum of money in R&D; as a result, it retains

Question

Calvert Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Calvert doesn't pay any dividends and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Calvert's stock. The pension fund manager has estimated Calvert's free cash flows for the next 3 years as follows: $1.2 million, $2.5 million, and $4.1 million. After the third year, free cash flow is projected to grow at a constant 5%. Calvert's WACC is 10%, the market value of its debt and preferred stock totals $10.9256 million, and it has 2.5 million shares of common stock outstanding. What is an estimate of Calvert's price per share? a. $30.07 b. $20.25 c. $28.37 d. $24.00 e. $17.50

Explanation / Answer

Year Nature Amount WACC Factor @ 10% Market Value a b c = a*b 1 Free Cash Flow $1.20 0.9091 $1.0909 2 Free Cash Flow $2.50 0.8264 $2.0661 3 Free Cash Flow $4.10 0.7513 $3.0804 3 Market Value at the end of Year 3 $86.10 0.7513 $64.6882 Total $70.9256 Less: Market Value of Debt & preferred stock $10.9256 Market Value of Equity (a) $60.0000 # of shares outstanding (b) 2.5 Price per share (c = a/b) $24.00 Hence, the correct answer is Option d - $24.00 Market Value at the end of Year 3 = Free Cashflow at year 4 / (WACC - Growth Rate) = ($4.10 * 1.05) / (0.10 - 0.05) = $86.10

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