Question #25

Reading: Reading 21 Free Cash Flow Valuation

PDF File: Reading 21 Free Cash Flow Valuation.pdf

Page: 11

Status: Correct

Correct Answer: A

Part of Context Group: Q24-25
Shared Context
- The value of TOY, Inc.'s stock given the above assumptions, is closest to: A) $50.86. B) $64.71. C) $61.57.
Question
Senior management of TOY Inc. is considering selling the company to a rival firm that has offered $450 million. If the current market price represents the fair value of equity and TOY Inc. maintains its target capital structure, the bid represents a price that is:
Answer Choices:
A. less than the total value of the firm
B. about the same total value of the firm
C. greater than the total value of the firm
Explanation
The total value of a firm is the total market value of equity plus the total market value of debt. The total value of equity is $56.00 per share × 5,000,000 shares = $280 million. Equity represents 70.0% of the capital structure. The total value of the firm is thus $280 million/0.70 = $400 million. An offer of $450 million is a premium of $50 million – a price greater than the current value of the firm.
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