Consider the following information about a firm (in millions of dollars): EBIT 2021 10 2022 12 2023 12.48 The firm faces a tax rate of 21%. The firm's rate of retum on debt is 3%. The risk free rate is 2%. Excess returns on the market are 7% per year over the risk free rate (historical average). Comparable firms (all with the target debt percentage, no need to "relever" the beta) have an equity beta of 1.2. The firm has 20 million shares outstanding. Current debt is $30 million. Estimate the value of the stock price using the following method: 1. Define the Free Cash Flow (FCF) as the total cash flow available to the entire firm. FCF = [EBIT * (1 - tax rate)] + Depreciation - Capital Expenditures - Change in Net Working Capital For now, assume Depreciation - Capital Expenditures and Change in Net Working Capital = 0. Compute the free cash flow in each year 2021, 2022, and 2023. 2. Compute the WACC. Assume that the firm has a target capital structure of 20% of the firm financed by debt. 3. Compute the Enterprise Value of the firm by discounting future free cash flows. After 2023, assume that EBIT grows as a perpetuity at a constant rate identical to the rate of growth from 2022 to 2023. Assume cash = 0. 4. Compute the price per share. Assume that the firm has issued no call options. Discussion 1. Explain why practitioners make the assumption that the firm holds the target debt ratio when computing the WACC. 2. Suppose the firm had call options outstanding. How would the presence of options affect the price per share? Reference Rosenbaum, Joshua and Pearl, Joshua. 2009. Investment Banking. Hoboken, New Jersey: John Wiley and Sons