McClelland Enterprises invests a lot of money in RD and as a

McClelland Enterprises invests a lot of money in R&D, and as a result it retains and reinvests all of its earnings instead of paying dividends. A pension fund manager is interested in purchasing McClelland’s stock and has estimated its free cash flows for the next 3 years as follows: $4 million, $7 million, and $12 million. After the 3rd year, FCF is projected to grow at a constant 9 percent. McClelland’s WACC is 15 percent, its debt and preferred stock total $40 million, and it has 2 million shares of common stock outstanding. What is the value of McClelland’s stock price?

I know the answer is $60.00 but I don\'t get how to solve it. May I know step-by-step?

Solution

FCF1 = $4 million
FCF2 = $7 million
FCF3 = $12 million

Growth Rate, g = 9%
WACC = 15%

FCF4 = FCF3 * (1 + g)
FCF4 = $12 million * 1.09
FCF4 = $13.08 million

Value of Firm at the end of Year 3 = FCF4 / (WACC - g)
Value of Firm at the end of Year 3 = $13.08 million / (0.15 - 0.09)
Value of Firm at the end of Year 3 = $218 million

Value of Firm = $4 million / 1.15 + $7 million / 1.15^2 + $12 million / 1.15^3 + $218 million / 1.15^3
Value of Firm = $160 million

Value of Equity = Value of Firm - Value of Debt and Preferred Stock
Value of Equity = $160 million - $40 million
Value of Equity = $120 million

Price per share = Value of Equity / Number of common stock outstanding
Price per share = $120 million / 2 million
Price per share = $60.00