Decker Tires' free cash flow was just FCF₀ = $1.32.Analysts expect the company's free cash flow to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter.The WACC for this company 9.00%.Decker has $4 million in short-term investments and $14 million in debt and 1 million shares outstanding.What is the best estimate of the stock's current intrinsic price?

Question

Quizplus · Accepted Answer

To estimate the stock's current intrinsic price, we first calculate the future free cash flows based on the given growth rates and then discount them back to the present value using the WACC. The formula for the terminal value at Year 3, using the Gordon Growth Model since the cash flow grows at a constant rate thereafter, is FCF3 * (1+g) / (WACC - g), where FCF3 is the free cash flow in Year 3, g is the constant growth rate, and WACC is the weighted average cost of capital.1. Calculate future free cash flows:   - Year 1: $1.32 * 1.30 = $1.716   - Year 2: $1.716 * 1.10 = $1.8876   - Year 3: $1.8876 * 1.05 = $1.981982. Calculate the terminal value at Year 3:   - TV3 = $1.98198 * (1.05) / (0.09 - 0.05) = $52.102633. Discount the future cash flows and the terminal value back to the present value:   - PV of Year 1 FCF = $1.716 / (1 + 0.09)^1 = $1.57569   - PV of Year 2 FCF = $1.8876 / (1 + 0.09)^2 = $1.58753   - PV of Year 3 FCF (including TV) = ($1.98198 + $52.10263) / (1 + 0.09)^3 = $42.748784. Sum the present values of the cash flows to get the total value of the firm:   - Total value = $1.57569 + $1.58753 + $42.74878 = $45.9125. Adjust for net debt (debt - short-term investments):   - Net debt = $14 million - $4 million = $10 million6. Calculate the equity value by subtracting net debt from the total value:   - Equity value = $45.912 million - $10 million = $35.912 million7. Divide the equity value by the number of shares to get the price per share:   - Price per share = $35.912 million / 1 million shares = $35.912The closest answer to our calculation is $34.87, which is option D.

Decker Tires' Free Cash Flow Was Just FCF0 = $1

Decker Tires' Free Cash Flow Was Just FCF₀ = $1