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Corporate bonds for A Inc. have an annual yield to maturity of 12% and market value of $18,000. Preferred shares of A Inc. just paid a dividend of $1 per share and are expected to grow by 2% every year. The market discount rate for A Inc. preferred shares is 8% and there are 1000 preferred shares outstanding. Common shares of A Inc. currently are $2 per share with 15000 shares outstanding. The market discount rate for common shares is 15%. The tax rate is 20% for all corporations.
a) If historically the P-E ratio is 15 for corporations like A Inc. and A Inc's most recent profit was $1500, is A Inc.'s stock over or under-valued by the market based on the P-E Ratio?
b) Calculate the weighted average cost of capital for A Inc.
c) A Inc. does not pay dividends on its common shares. It's free cash flow today was $5000. That is projected to increase for the next three years by 10% annually. After that it is only projected to increase by 3% forever after. Calculate the estimated value of A Inc. today using the WACC you calculated in part b).
d) What is the estimated share price of A Inc. based on your calculation in part c)?
e) Based on the estimated share price of A Inc. in part c), is A Inc. over- or under-valued? Briefly explain.
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