River Enterprises has $502 million in debt and 22 million shares of equity outstanding. Its excess cash reserves are $ 15 million. They are expected to generate $195 million in free cash flows next year with a growth rate of 2 % per year in perpetuity. River Enterprises' cost of equity capital is 13 %. After analyzing the company, you believe that the growth rate should be 3 % instead of 2 %. How much higher (in dollars) would the price per share be if you are right? g

Question

Business

Jairo Herrera

22 May, 20:50

River Enterprises has $502 million in debt and 22 million shares of equity outstanding. Its excess cash reserves are $ 15 million. They are expected to generate $195 million in free cash flows next year with a growth rate of 2 % per year in perpetuity. River Enterprises' cost of equity capital is 13 %. After analyzing the company, you believe that the growth rate should be 3 % instead of 2 %. How much higher (in dollars) would the price per share be if you are right? g

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Answers (1)

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Monique Brandt · Answer 1

The stock price would be higher by $7.37

Explanation:

Free cash flow to equity = 195 million with a growth rate of 2% in perpetuity

Value of equity = Free cash flow to equity : (Ce - g) = 195 million : (13% - 2%)

= 190 : 0.11 = $1,772,727,272.73 = $1,773 million

If growth rate is 3%, value of equity = 195 : (13%-3%) = 195 : 0.1 = $1,950 million

a. Value of stock = (1,773 + 15) million : 22 = $81.27

b. Value of stock with 3% = 1,950 : 22 = $88.64

Thus stock price would be higher by = b-a = $7.37