Franktown Motors is expected to have an EBIT of $687,400 next year. Depreciation, the increase in net working capital, and capital spending are expected to be $48,000, $7,000, and $42,000, respectively. All cash flow items are expected to grow at 6 percent per year for four years. After Year 5, the CFA* is expected to grow at 2.1 percent indefinitely. The company currently has $3.2 million in debt and 250,000 shares outstanding. The company's WACC is 9.9 percent and the tax rate is 21 percent. What is the price per share of the company's stock?

Question

Quizplus · Accepted Answer

1. Calculate the EBIT after depreciation:

EBIT = $687,400 + $48,000 = $735,400

2. Calculate the Free Cash Flow to the Firm (FCFF) for each year:

Year 1: 
FCFF = EBIT(1 - tax rate) + depreciation - increase in NWC - capital spending 
FCFF = $735,400(1 - 0.21) + $48,000 - $7,000 - $42,000 = $526,540

Year 2: 
FCFF = ($526,540)(1.06) = $558,446

Year 3: 
FCFF = ($558,446)(1.06) = $592,402

Year 4: 
FCFF = ($592,402)(1.06) = $628,515

Year 5: 
FCFF = ($628,515)(1.06) = $666,994

FCFF after Year 5: 
FCFF = ($666,994)(1.021)/(0.099 - 0.021) = $8,802,080

3. Calculate the Total Present Value of the FCFF:

PV = ($526,540 / (1 + 0.099)^1) + ($558,446 / (1 + 0.099)^2) + 
($592,402 / (1 + 0.099)^3) + ($628,515 / (1 + 0.099)^4) + 
($666,994 / (1 + 0.099)^5) + ($8,802,080 / (1 + 0.099)^5)

PV = $9,210,892

4. Calculate the Enterprise Value (EV):

EV = PV of FCFF + MV of debt - cash and cash equivalents 
MV of debt = $3.2 million 
Cash and cash equivalents are not given in the problem

EV = $9,210,892 + $3.2 million - cash and cash equivalents

5. Calculate the Market Value of Equity (MVE):

MVE = EV - MV of debt 
MVE = $9,210,892 - $3.2 million = $6,010,892

6. Calculate the Price per Share:

Price per Share = MVE / number of shares outstanding 
Price per Share = $6,010,892 / 250,000 = $24.04

Therefore, the best choice is B, with the explanation above.

Franktown Motors Is Expected to Have an EBIT of $687,400