Nico Corporation expects to generate free-cash flows of $200,000 per year for the next five years. Beyond that time, free cash flows are expected to grow at a constant rate of 5 percent per year forever. If the firm's average cost of capital is 15 percent, the market value of the firm's debt is $500,000, and Nico has a half million shares of stock outstanding, what is the value of Nico's stock?

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The correct answer is A. The value of Nico's stock is $2.43.The value of the firm's equity is the present value of the firm's free cash flows. The free cash flows for the next five years are $200,000 per year. Beyond that time, free cash flows are expected to grow at a constant rate of 5 percent per year forever. The firm's average cost of capital is 15 percent. The market value of the firm's debt is $500,000, and Nico has a half million shares of stock outstanding.The value of the firm's equity is:$$V_e = \frac{FCF}{r - g} - D$$where:* $V_e$ is the value of the firm's equity* $FCF$ is the free cash flow* $r$ is the average cost of capital* $g$ is the growth rate of free cash flows* $D$ is the market value of the firm's debtPlugging in the numbers, we get:$$V_e = \frac{200,000}{0.15 - 0.05} - 500,000 = 2,000,000$$The value of Nico's stock is:$$V_s = \frac{V_e}{N}$$where:* $V_s$ is the value of Nico's stock* $N$ is the number of shares outstandingPlugging in the numbers, we get:$$V_s = \frac{2,000,000}{500,000} = 4$$Therefore, the value of Nico's stock is $4.

Nico Corporation Expects to Generate Free-Cash Flows of $200,000 Per