Problem 5 You have been hired to value the stock of a privately-held chain of grocery stores, Ergon, which is planning to offer its shares to the public. Ergon has 25,000 common shares outstanding. In addition to equity financing, the company is also financed with debt, which consists of one bond issue. The bond issue comprises bonds that have a face value of $1,000, mature in 5 years, and have an annual coupon rate of 7% (coupon payments are made semiannually at the end of each period). The company has a total of 1,000 bonds outstanding, and the yield-to-maturity on these bonds is 9% APR.2 In addition to operating assets, the company also owns a collection of expensive paintings that decorate the firms headquarters. These paintings have a current market value of $150,000. Other financial information is summarized in the table below. Based on your discussions with the management, you have projected growth rates for Ergons cash flows over the next 5 years. After year 5, you expect that cash flows will grow at 3% in perpetuity. All cash flows are received at the end of the year. The cash flow for the trailing twelve months has already occurred, and the next cash inflow is due one year from today. The annual discount rate for the firms free cash flows is 12%, and the tax rate is 30%. Compute the value of Ergons stock using the discounted cash flow method. Income statement and cash flow items for Ergon, trailing 12 months (TTM):

Financials Value in dollars

Sales revenue 4,800,000

COGS 4,220,000

SG&A 320,000

Depreciation and amortization 60,000

Capital expenditures 80,000

Increase in working capital 45,000

Estimated growth in free cash flow for Ergon, years forward:

Year: FCF Growth

1 30%

2 25%

3 20%

4 15%

5 10%