Covan, Inc., is expected to have the following free cash flows:
| Year | 1 | 2 | 3 | 4 | p |
| FCF | 10 | 12 | 13 | 14 | Grow by 4% per year |
Required
Covan has 8 million shares outstanding, $3 million in excess cash, and it has no debt. If its cost of capital is 12%, what should its stock price be?
Solution
Given:
CF1 = $10 million
CF2 = $12 million
CF3 = $13 million
CF4 = $14 million
Terminal growth rate, g = 4%
No. of shares = 8 million
Cash = $3mn
Debt = 0
Cost of capital, r = 12%
Workings
Solution to part a.
Terminal value (at the end of year 4) = CF4*(1+g)/(r-g)
= 14*(1+4%)/(12%-4%)……………………………………..
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