Use the information for the question(s)below.
Gonzales Corporation generated free cash flow of $88 million this year.For the next two years,the company's free cash flow is expected to grow at a rate of 8%.After that time,the company's free cash flow is expected to level off to the industry long-term growth rate of 4% per year.Suppose the weighted average cost of capital is 10% and Gonzales Corporation has cash of $100 million,debt of $300 million,and 100 million shares outstanding.
-What is Gonzales Corporation's expected current share price?

Question

Quizplus · Accepted Answer

First, we need to calculate the future free cash flows for years 1 and 2:
Year 1: $88 million x (1 + 8%) = $95.04 million
Year 2: $95.04 million x (1 + 8%) = $102.7 million

Next, we need to calculate the present value of those future free cash flows using the WACC:
PV of Year 1 FCF = $95.04 million / (1 + 10%) = $86.40 million
PV of Year 2 FCF = $102.7 million / (1 + 10%)^2 = $85.09 million

We can now calculate the present value of the company's terminal value, which is the free cash flow in year 3 (when it levels off) divided by the difference between the WACC and the long-term growth rate:
Terminal Value = ($102.7 million x (1 + 4%)) / (10% - 4%) = $1,771.57 million

We can then calculate the present value of the terminal value:
PV of Terminal Value = $1,771.57 million / (1 + 10%)^2 = $1,276.76 million

Adding the present value of the future free cash flows and the present value of the terminal value gives us the total enterprise value:
Total Enterprise Value = $86.40 million + $85.09 million + $1,276.76 million = $1,448.25 million

To get the equity value, we subtract net debt (debt minus cash) from the enterprise value:
Equity Value = $1,448.25 million - ($300 million - $100 million) = $1,248.25 million

Finally, we divide the equity value by the number of outstanding shares to get the expected share price:
Share Price = $1,248.25 million / 100 million = $12.48
Adding the cash per share, we get:
Expected Current Share Price = $12.48 + ($100 million / 100 million) = $14.48, which is closest to answer choice C.

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