Question

1 a) IHI, Inc. forecasts that its free cash flow in the coming year, i.e., at t=1, will be -$5 million, but then its FCF will turn positive. At t=2 IHIs FCF will be $35 million, and at t=3 IHI will be $58 million. After year 3, FCF is expected to grow at a constant rate of 5% forever. If IHI’s weighted average cost of capital is 18%, what is the firms value of operations, in millions?

1. b) A review of Island Hotels, Inc.’s financial statements show that IHI has $150 million in short-term investments that are not necessary to support the current level of operations. Also, IHI has a market value of $175 million in debt, and $75 million in preferred stock, and 5 million shares of common stock outstanding. Using this new information about IHI’s financial statements and the information from problem 1a, what is your best estimate for the value of a share of IHI’s common stock?

Answer 1

B5 f+B4 1.05 PVIF 18% Present value 2 FCF1 3 FCF2 4 FCF3 5 FCF4 6 Firm value year4 |$ 35.00 58.00 60.90 468.46 60.90/(1896-596) 0.847 $ 0.718 $ 0.609 $ 25.14 35.30 0.609 $ 285.12 9 Firm's value of operations$ 345.56