College of Central Florida Free Cash Flow Valuation Model Questions

Your employer, a midsized human resources management company, is considering

expansion into related fields, including the acquisition of Temp Force Company, an

employment agency that supplies word processor operators and computer programmers

to businesses with temporarily heavy workloads. Your employer is also considering the

purchase of Biggerstaff & McDonald (B&M), a privately held company owned by two

friends, each with 5 million shares of stock. B&M currently has free cash flow of

$24 million, which is expected to grow at a constant rate of 5%.

B&M’s financial statements report short-term investments of $100 million,

debt of $200 million, and preferredstock of $50 million.

B&M’s weighted average cost of capital (WACC) is 11%.

Answer thefollowing questions:

a. Describe briefly the legal rights and privileges of common stockholders.

b. What is free cash flow (FCF)? What is the weighted average cost of capital? What is

the free cash flow valuation model?

c. Use a pie chart to illustrate the sources that comprise a hypothetical company’s total

value. Using another pie chart, show the claims on a company’s value. How is equity

a residual claim?

d. Suppose the free cash flow at Time 1 is expected to grow at a constant rate of gL

forever. If gL , WACC, what is a formula for the present value of expected free

cash flows when discounted at the WACC? If the most recent free cash flow is

expected to grow at a constant rate of gL forever (and gL , WACC), what is a

formula for the present value of expected free cash flows when discounted at

the WACC?

e. Use B&M’s data and the free cash flow valuation model to answer the following

questions:

(1) What is its estimated value of operations?

(2) What is its estimated total corporate value? (This is the entity value.)

(3) What is its estimated intrinsic value of equity?

(4) What is its estimated intrinsic stock price per share?