Union Corp. reported free cash flow to firm (FCFF) of $770 million in a recent financial year. The firm also had $4 billion in debt outstanding on the books, which was rated BBB (carrying default spread of 3% above the Treasury bond rate of 3%). The beta of the stock is 1.2, and there were 200 million shares outstanding (trading at $60 per share), with a book value of $5 billion. Equity risk premium is 5.5%. Tax rate is 36%

The firm has new technology, which gave the firm competitive advantage to obtain a higher growth rate of 7%. However, the advantage is likely to disappear in 5 years and the firm will operate like a mature firm, which has a growth rate of about 3%.

(1) Which firm valuation model should you use for Union Corp? Write down the formula.

(2) What is cost of capital for the first stage?

(3) What is the present value of cash flows in the first stage?

(4) What is cost of capital for the mature stage? Assume stock beta becomes 1 and debt rating changes to A, which has 2% of default spread

(5) What is terminal value? And what is the present value of terminal value?

(6) What is firm value?

(7) Is the stock price currently undervalued or overvalued?