1. A trip to the South Pacific
You decided to make monthly deposits into your savings account to have $8,000 by next August, which is 7 full months away, for your trip to the South Pacific. In total, you expect to make 8 deposits, with the first deposit today. How much do you need to put aside each month, assuming that your savings account earns monthly interest rate at the rate of 1% per month?
2. How much is the stock worth?
You learned that Brussels Cafes, a company owning and operating four extremely successful restaurants in Milwaukee, is doing an IPO, or Initial Public Offering, next month. They are offering their stock at $32 per share. You are interested in pricing their shares, in order to identify whether you should buy any. The firm has no debt, just equity capital. Since you often visit their restaurants, you made some predictions about their annual cash flow. You expect the after-tax net cash flow, which the firm would immediately pay out to shareholders, to be $450K in each of the next four years, $500K in year 5, and in years 6 the firm’s cash flow would be $540K. Starting year 6, that cash flow would continue in perpetuity, growing by 4% per year. Based on these predictions, calculate the maximum price you would be willing to pay for the stock, assuming (1) you believe the appropriate cost of equity capital for the firm is 10% per year, (2) the tax on dividend distributions you pay is 0%, and (3) the number of fully diluted shares outstanding of the company is 200,000? Would you buy the stock at the IPO at the offering price of $32 per share?
ANSWER: Maximum price per share: _____________________
What would you do? __________________________________________________