Valuing a business* Phoenix Corp. faltered in the recent recession but is recovering.
Phoenix’s recovery will be complete by 2024, and there will be no further growth in net income or free cash flow.
- a. Calculate the PV of free cash flow, assuming a
cost of equity of 9%. - b. Assume that Phoenix has 12 million shares outstanding. What is the price per share?
- c. Confirm that the expected
rate of return on Phoenix stock is exactly 9% in each of the years from 2020 to 2024.
a)
To determine: Present value of free cash flow
Explanation of Solution
Compute the present value of free cash flow:
Hence, the present value is $24.8 million.
b)
To determine: Price per share
Explanation of Solution
Note:
Assume no debt, the share price are as follows,
Hence, the price per share is $2.04.
c)
To confirm: The expected rate of return is 9%.
Explanation of Solution
Compute PV of the cash flows at various points in time:
Compute rate of return using the formula
Thus, the above calculation shows that the rate of return on Company P is exactly 9%.
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