Use the free cash flow valuation model to estimate

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Unformatted text preview: following table. Free cash flow Year (t ) FCFt Other data 700,000 Growth rate of FCF, beyond 2007 to infinity 800,000 Weighted average cost of capital 2006 950,000 Market value of all debt 2007 1,100,000 2004 2005 $ 2% 8% $2,700,000 Market value of preferred stock $1,000,000 Number of shares of common stock outstanding 1,100,000 a. Use the free cash flow valuation model to estimate CoolTech’s common stock value per share. b. Judging on the basis of your finding in part a and the stock’s offering price, should you buy the stock? 346 PART 2 Important Financial Concepts c. Upon further analysis, you find that the growth rate in FCF beyond 2007 will be 3% rather than 2%. What effect would this finding have on your responses in parts a and b? LG5 7–18 Book and liquidation value The balance sheet for Gallinas Industries is as follows. Gallinas Industries Balance Sheet December 31 Assets Liabilities and Stockholders’ Equity Cash $ 40,000 Marketable securities Accounts receivable Inventories Accounts payable $100,000 60,000 Notes payable 30,000 120,000 Accrued wages 30,000 160,000 Total current liabilities $160,000 Total current assets $380,000 Long-term debt $180,000 Land and buildings (net) $150,000 Preferred stock $ 80,000 Machinery and equipment 250,000 Total fixed assets (net) $400,000 Total assets Common stock (10,000 shares) Total liabilities and stockholders’ equity 360,000 $780,000 $780,000 Additional information with respect to the firm is available: (1) Preferred stock can be liquidated at book value. (2) Accounts receivable and inventories can be liquidated at 90% of book value. (3) The firm has 10,000 shares of common stock outstanding. (4) All interest and dividends are currently paid up. (5) Land and buildings can be liquidated at 130% of book value. (6) Machinery and equipment can be liquidated at 70% of book value. (7) Cash and marketable securities can be liquidated at book value. Given this information, answer the following: a. What is Gallinas Industries’ book value per share? b. What is its liquidation value per share? c. Compare, contrast, and discuss the values found in parts a and b. LG5 7–19 Valuation with price/earnings multiples For each of the firms shown in the following table, use the data given to estimate their common stock value employing price/earnings (P/E) multiples. Firm Expected EPS Price/earnings multiple A $3.00 6.2 B 4.50 10.0 C 1.80 12.6 D 2.40 8.9 E 5.10 15.0 CHAPTER 7 Stock Valuation 347 LG6 LG4 7–20 Management action and stock value REH Corporation’s most recent dividend was $3 per share, its expected annual rate of dividend growth is 5%, and the required return is now 15%. A variety of proposals are being considered by management to redirect the firm’s activities. Determine the impact on share price for each of the following proposed actions, and indicate the best alternative. a. Do nothing, which will leave the key financial variables unchanged. b. Invest in a new machine that will increase the div...
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