Gunco Industries invests a large sum of money in R&D; as a result, it retains an
ID: 2758518 • Letter: G
Question
Gunco Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of it earnings. In other words, Gunco 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 Gunco’s stock. The pension fund manager has estimated Gunco’s FCF for the next 4 years as follows: $4 million, $5 million, $11 million, and $14 million. After the forth year, FCF is projected to grow at a constant 5%. Gunco’s WACC is 10%, the market value of its debt and preferred stock totals $55 million, and it has 100 million shares of common stock outstanding. What is an estimate of Gunco’s price per share? You must show your work (your calculator inputs and math) to receive full credit.
Explanation / Answer
Solution:
Year
FCF
Discount factor @10%
Present value
1
1000000
0.909090909
909,090.91
2
4000000
0.826446281
3,305,785.12
3
5000000
0.751314801
3,756,574.00
4
11000000
0.683013455
7,513,148.01
5 to infinity
231000000**
0.683013455
157,776,108.19
Total
173,260,706.24
shares of common stock outstanding
100,000,000
estimate of Gunco’s price per share
1.73
Since the growth is constant
**Value at end of year 4 = Expected FCF/(WACC-Growth)
11*1.05/(.10-.05)
231000000
Year
FCF
Discount factor @10%
Present value
1
1000000
0.909090909
909,090.91
2
4000000
0.826446281
3,305,785.12
3
5000000
0.751314801
3,756,574.00
4
11000000
0.683013455
7,513,148.01
5 to infinity
231000000**
0.683013455
157,776,108.19
Total
173,260,706.24
shares of common stock outstanding
100,000,000
estimate of Gunco’s price per share
1.73
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