Question

3. The multi-stage valuation model Consider the case of Flying Cow Aviation Inc.: Flying Cow Aviation Inc. is expected to generate a free cash flow (FCF) of $1,180,000 this year, and the FCF is expected to grow at a rate of 14% over the following two years (FCF 2 and FCF3). After the third year, however, the company's FCFs are expected to grow at a constant rate of 6% per year, which will last forever (FCF 4-0). If Flying Cow's weighted average cost of capital (WACC) is 12%, complete the following table and compute the current value of Flying Cow's operations. Round all dollar amounts to the nearest whole dollar, and assume that the firm does not have any nonoperating assets in its balance sheet and that all FCFs occur at the end of each year. Year PV(FCF) CFt $1,180,000 FCF1 FCF2 FCF3 FCF4 Horizon Value4 Vop= Flying Cow's debt has a market value of $16,875,959, and Flying Cow has no preferred stock in its capital structure. If Flying Cow has 100,000 shares of common stock outstanding, then the total value of the company's common equity is $ , and the estimated intrinsic value per share of its common stock is $ per share. Assume the following: • The end of Year 3 differentiates Flying Cow's short-term and long-term FCFs. • Professionally-conducted studies have shown that more than 80% of the average company's share price is attributable to long-term- rather than short-term-cash flows.

Answer 1

Year	Growth rate	Cash flow computation	Cash flow	PV factor @12%	Cash flow * PV factor
1			$         1,180,000	0.8929	$         1,053,571
2	14.00%	1180000*(1+14%)	$         1,345,200	0.7972	$         1,072,385
3	14.00%	1345200*(1+14%)	$         1,533,528	0.7118	$         1,091,535
3			$       27,092,328	0.7118	$       19,283,784
				Current firm value	$       22,501,276
Current Cash flow	$           1,533,528		$       31,151,056
Rate of return	12.00%
Growth Rate	6.00%
Firm value as per Cash flow discount model	=Current Cash flow*(1+Growth rate)/(Rate of return-Growth Rate)
Firm value as per Cash flow discount model	=1533528*(1+0.06)/(0.12-0.06)
Firm value as per Cash flow discount model=	$         27,092,328
Company's value	$         22,501,276
Debt value	$        (16,875,959)
Equity value	$           5,625,317
No of shares	100,000
Share price per share	=5625316.51020408/100000
Share price per share	$                   56.25
Year	Growth rate	Cash flow computation	Cash flow	PV factor @12%	Cash flow * PV factor	%age=PV of cashflow/Total
1			$         1,180,000	0.8929	$         1,053,571	4.68%
2	0.14	1180000*(1+14%)	$         1,345,200	0.7972	$         1,072,385	4.77%
3	0.14	1345200*(1+14%)	$         1,533,528	0.7118	$         1,091,535	4.85%
3			$       27,092,328	0.7118	$       19,283,784	85.70%
				Total	$       22,501,276
As we can see that long term cash flow is 85.70%. Professional studies say longterm cash flow is more than 80% so option D is correct.