CFA Level II ExamEquity InvestmentsMedium
An equity analyst is valuing 'BioGen Corp.', a biotechnology company with no current dividends but significant expected free cash flow to equity (FCFE) in the future. The analyst projects FCFE for the next three years to be $2.00, $2.50, and $3.00 per share, respectively. After year 3, FCFE is expected to grow at a constant rate of 4% indefinitely. If the required rate of return for BioGen Corp. is 12%, what is the intrinsic value per share today?
- A$29.10
- B$35.80
- C$32.95
- D$38.65
Show answer & explanationAnswer & explanation
Correct answer: B. $35.80
The intrinsic value per share is calculated by discounting the projected FCFE for the explicit forecast period and the terminal value back to the present. The terminal value is calculated using the Gordon Growth Model based on the FCFE in the first year of stable growth.
Why the other options are wrong
- A. Incorrect. This value is significantly lower and likely results from a major calculation error.
- C. Incorrect. This value might result from an error in calculating the terminal value or discounting, such as using FCFE3 instead of FCFE4 for the terminal value numerator.
- D. Incorrect. This value might result from an error in calculating the terminal value or discounting.
Multi-Stage FCFE Model
A valuation model that projects Free Cash Flow to Equity (FCFE) for an explicit forecast period and then estimates a terminal value for the period beyond, discounting all values back to the present.
- Appropriate for companies with varying growth rates over time.
- Combines an explicit forecast period with a stable growth period.
- Terminal value often calculated using the Gordon Growth Model.
Memory trick: Forecast Cash Flows, Then Grow, Discount for Value Now!