Office Max is a fast growing supplier of office products. Analysts project the f
ID: 2772981 • Letter: O
Question
Office Max is a fast growing supplier of office products. Analysts project the following cash flows (FCFs) during the next 5 years, after which FCF is expected to grow at a constant rate of 7 percent. Office Max’s cost of capital (WACC) is 11%
Time 1 2 3 4 5
Free cash flow ($ million) -$20 $30 $40 $45 $52
a. What is Office Max’s terminal value of cash flows at year 5 (i.e., V5)?
b. What is the current value of operations (total PV at time 0 or V0) for Office Max?
c. Suppose Office Max has $10 million in non-operating assets, $40 million in debt, $30 million in preferred stocks, and 10 million shares of stock. What is the current price per share of Office Max?
*Please explain step by step so I can understand.
Explanation / Answer
Answer (a)
Office Max’s terminal value of cash flows at year 5 = $ 1,391 Million
Answer (b)
Current Value of operations PV = $ 921.55 Million
Answer (c)
Current Market Price = $ 84.155 or $ 84.16 (rounded off)
working
($ Million)
1
2
3
4
5
Free Cash Flow
-$ 20
$ 30
$ 40
$ 45
$ 52
Cash flow growth rate after 5th year, g = 7% or 0.07
Cost of Capital of Office Max (WACC), r = 11% or 0.11
Expected FCF in Year 6 = $ 52 * 1.07 = $ 55.64
Terminal Value of Free Cash Flows at year 5 which are expected to grow at a constant rate of 7% after 5th year can be calculated using the formula
Terminal Cash Flow TCF = FCF in year 6 / (cost of capital – growth rate) = $ 55.64 /(0.11 – 0.07)
= $ 55.64 / 0.04 = $ 1,391
Current Value of Operations can be calculated using the formula
Current Value of Operations PV = FCF yr 1/(1+r) + FCF yr 2/(1+r)^2 + FCF yr 3/(1+r)^3 + FCF yr 4 / (1+r)^4 + FCF yr 5 /(1+r)^5 + TCF / (1+r)^5
PV = (-$ 20 / 1.11) + ($ 30/1.11^2) + ($40/1.11^3) + ($ 45 /1.11^4) + ($ 52 / 1.11^5) + ($ 1,391/1.11^5)
= (-$ 20 / 1.11) + ($ 30/1.2321) + ($40/1.3676) + ($ 45 /1.5181) + ($ 52 / 1.6851) + ($ 1,391/1.6851)
= - $ 18.02 + $ 24.35 + $ 29.25 + $ 29.64 + $ 30.86 + $ 825.47
= $ 921.55
Present Value of the Firm = non-operating Assets +Debt +Preferred Stocks + Equity Capital (No shares * Current Market Price )
$ 921.55 Million = $ 10 Million + $ 40 Million + $ 30 Million + 10 Million shares of common stock * current market price
10 Million shares of common stock * current market price = $ 921.55 Million - $ 10 Million - $ 40 Million - $ 30 Million
10 Million shares of common stock * current market price = $ 841.55 Million
Current Market Price = $ 841.55 Million / 10 Million shares = $ 84.155 or $ 84.16 (rounded off)
($ Million)
1
2
3
4
5
Free Cash Flow
-$ 20
$ 30
$ 40
$ 45
$ 52
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.