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24 Feb 2018

a. What does it mean when a company's free cash flow is negative in one or more years?

b. Do negative values of free cash flow in any way alter or invalidate the notion that a company's fair market value equals the present value of its free cash flows discounted at the company's weighted average cost of capital?

c. Suppose a company's free cash flows were expected to be negative in all future periods. Can you conceive of any reasons for buying the company's stock?

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Keith Leannon
Keith LeannonLv2
26 Feb 2018

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A) Do negative values of free cash flow in any way alter or invalidate the notion that a company’s fair market value equals the present value of its free cash flows discounted at the company’s weighted average cost of capital?

B) Suppose a company’s free cash flows were expected to be negative in all future periods. Can you conceive of any reasons for buying the company’s stock?

Your employer, a mid-sized human resources management co. is considering expansion into related fields, including the acquisition of Co. B. Your employer is also considering the purchase of B&M, a privately held company owned by two friends, each with 5 million shares in stock. B&M currently has free cash flow of $24 million, which is expected to growat a constant rate of 5%. B&M's financial statements report short-term investments of $100 million, debt of $200 million, and preferred stock of $50 million. B&M's weighted average cost of capitall is 11%.

Suppose the free cash flow at Time 1 is expected to grow at a constant rate of g1 forever. If g1<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 g1 forever (and g1<WACC), what is a formulat for the present value of expected free cash flows when discounted at the WACC?

Assume today is December 31, 2013. Barrington Industries expects that its 2014 after-tax operating income [EBIT(1 – T)] will be $450 million and its 2014 depreciation expense will be $65 million. Barrington's 2014 gross capital expenditures are expected to be $110 million and the change in its net operating working capital for 2014 will be $30 million. The firm's free cash flow is expected to grow at a constant rate of 6% annually. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 9%; the market value of the company's debt is $2.35 billion; and the company has 170 million shares of common stock outstanding. The firm has no preferred stock on its balance sheet and has no plans to use it for future capital budgeting projects. Using the free cash flow valuation model, what should be the company's stock price today (December 31, 2013)? Round your answer to the nearest cent. Do not round intermediate calculations

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