Question #86
Reading: Reading 21 Free Cash Flow Valuation
PDF File: Reading 21 Free Cash Flow Valuation.pdf
Page: 41
Status: Unattempted
Part of Context Group: Q85-86
Shared Context
Question
The current market price of BIC is $62.50 per share, and the current year's FCFE is $1.75 million. Using a two-stage growth model to find the estimated the firm's value, the current market price BIC is most accurately described as:
Answer Choices:
A. overvalued
B. undervalued
C. fairly valued
Explanation
FCFE = FCFF − Interest expense × (1 − T) + New borrowing.
Year
0
1
2
3
4
Growth rate
25.0%
25.0%
25.0%
6.0%
FCFE in mil$
$1.750
$2.188
$2.734
$3.418
$3.623
The terminal value is $3,623/(0.16 – 0.06) = $36,230 million. The calculator inputs: CF0 = 0,
CF1 = $2,188, CF2 = $2,734, CF3 = $3,418 + $36,230 = $39,648, I = 16, NPV = $29.319
million.
Per share price is $29,319,000/500,000 = $58.64. The stock appears to be overvalued at
the current market price of $62.50 per share, as our estimated value of $58.64 suggests
that the market price is too high.