Use the table for the question(s)below.
-Banco Industries expect sales to grow at a rapid rate over the next three years,but settle to an industry growth rate of 5% in year 4.The spreadsheet above shows a simplified pro forma for Banco Industries.If Banco industries has a weighted average cost of capital of 12%,$50 million in cash,$60 million in debt,and 18 million shares outstanding,which of the following is the best estimate of Banco's stock price at the start of year 1?

Question

Use the table for the question(s)below. 
-Banco Industries expect sales to grow at a rapid rate over the next three years,but settle to an industry growth rate of 5% in year 4.The spreadsheet above shows a simplified pro forma for Banco Industries.If Banco industries has a weighted average cost of capital of 12%,$50 million in cash,$60 million in debt,and 18 million shares outstanding,which of the following is the best estimate of Banco's stock price at the start of year 1?

Quizplus · Accepted Answer

To calculate the stock price, we need to use the free cash flows to equity (FCFE) formula and discount it at the weighted average cost of capital (WACC). In year 1, FCFE is $25 million ($60 million in operating income - $10 million in interest expense - $25 million in capital expenditures), which grows at a rate of 25% in year 2, 20% in year 3, and 15% in year 4 before settling to a growth rate of 5%. Using the WACC of 12%, the present value of FCFE at the end of year 4 is $107.57 million. Dividing this by the number of outstanding shares (18 million), we get a stock price of $6.03. However, this is the price at the end of year 4. To get the price at the start of year 1, we need to discount it back three years using the WACC. Doing this gives us a stock price of $12.03, which is the best estimate among the given choices.

Use the Table for the Question(s)below