question archive West Fraser Timber Company (WFT) is expected to have free cash flow in the coming year of $2 million and its free cash flow is expected maintain at a sustainable growth rate of 4% per year
West Fraser Timber Company (WFT) is expected to have free cash flow in the coming year of $2 million and its free cash flow is expected maintain at a sustainable growth rate of 4% per year
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West Fraser Timber Company (WFT) is expected to have free cash flow in the coming year of $2 million and its free cash flow is expected maintain at a sustainable growth rate of 4% per year. It has a debt worth $10 million. It's equity cost of capital is 12%, cost of debt before tax is 6%, and it pays a corporate tax rate of 30%. If WFT Company maintains a debt-equity ratio of 0.5 and the company has 3 million common shares outstanding, what is the fair value of WFT stock?
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fair value of WFT stock = $12.35 per share
Step-by-step explanation
After tax cost of debt = before tax cost of debt*(1-tax rate) = 6*(1-0.30) = 4.2%
Cost of equity = 12%
Debt = $10 million
Debt / Equity = 0.5
$10 million / Equity = 0.5
Equity = $10 million / 0.5
Equity = $20 million
Total value of firm = value of debt + value of equity = $10 million + $20 million = $30 million
WACC = weight of debt * after tax cost of debt + weight of equity*Cost of equity
WACC = (10/30)*4.2 + (20/30)*12
WACC = 9.4%
WACC = 0.094
Total fair value of WFT = Free cash flow next year/(WACC - growth rate) = 2/(0.094 - 0.04) = $37.03703703 million
fair value of WFT stock = Total fair value of WFT/number of shares outstanding
fair value of WFT stock = $37.03703703 million/ 3 million
fair value of WFT stock = $12.35 per share
