An analyst is trying to estimate the intrinsic value of Burress Inc. The analyst has estimated...

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An analyst is trying to estimate the intrinsic value of BurressInc. The analyst has estimated the company's free cash flows forthe following years
Year Free Cash flow
1 $3,000
2 $4,000
3 $5,000
An analyst estimates that after 3 years (t=3) the company'scashflows will grow at a constant rate of 6% per year. the analystestimates that the company's WACC is 10%. the company's debt andpreferred stock has a total market value of $25,000 and there are1,000 outstanding shares of common stock. If the price of the stockis currently $80 per share, will you invest in it?

Answer & Explanation Solved by verified expert

3.6 Ratings (520 Votes)

Horizon value at year 3 = CF3(1+g)/(WACC-g)

= 5000(1+.06)/(.10-.06)

= 5000 * 1.06 / .04

= $ 132500

PRESENT VALUE OF FIRM =[PVF10%,1*CF1]+[PVF10%,2*CF2]+[PVF10%,3*CF3]+[PVF10%,3*HORIZON VALUE]

=[.90909*3000]+ [.82645*4000]+[.75131*5000]+[.75131*132500]

= 2727.27+ 3305.8+ 3756.55+ 99548.58

= $ 109338.20

Value of equity = value of firm - value of debt and preferred stock

= 109338.20 - 25000

= 84338.20

Fair value of common stock per share = 84338.20/1000 = $ 84.34 per share

since the fair value of share is higher than actual price of $ 80 per share ,you should invest in this stock .

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Transcribed Image Text

An analyst is trying to estimate the intrinsic value of BurressInc. The analyst has estimated the company's free cash flows forthe following yearsYear Free Cash flow1 $3,0002 $4,0003 $5,000An analyst estimates that after 3 years (t=3) the company'scashflows will grow at a constant rate of 6% per year. the analystestimates that the company's WACC is 10%. the company's debt andpreferred stock has a total market value of $25,000 and there are1,000 outstanding shares of common stock. If the price of the stockis currently $80 per share, will you invest in it?