Solution 1:

a. Estimate the value of the firm and the value of the equity based upon this value. Value of the firm (V)= Market Value of equity (E) + Market Value of debt (D) E= $ 750 million D= $ 500 million V= $ 1,250 million Value of equity= V-D= $ 750 million Also, WACC= 8% Free Cash Flow i.e. FCF= $100 million Cost of equity=ke= 10% Post tax Cost of debt=kd= 5% Value of the firm= FCF/WACC= $1,250 million b. Estimate the value of equity, by discounting the cash flows to equity at the cost of equity. Given, Free Cash Flow i.e. FCF= $100 million Cost of equity=ke= 10% Post tax Cost of debt=kd= 5% Free cash flow to equity= FCF-debt payment= $75 million Value of equity= FCFE/Ke= $750 million c. Now assume that you had been told that the market value of equity was $850 million and that all of the other information remained unchanged. Answer parts a and b, using these new values. So, the new E= $850 million Free Cash Flow i.e. FCF= $100 million Cost of equity=ke= 10% Post tax Cost of debt=kd= 5% New WACC= 8.15% New Value of the firm= FCF/WACC= $1,227.27 million New Value of equity= V-D= $727.27 million Value of equity, by discounting the cash flows to equity at the cost of equity= $750

d. In practice, what needs to happen for the two valuation approaches (FCFF and FCFE) to give the same estimate of valu For the two valuation approaches to give the same value, the firm should be unlevered. In practise, FCFF and FCFE cashflows differ mainly because of payments made with respect to debt. Only if the firm doesnot use debt both the valuation approaches will give the same estimate of value.

Solution 2: a. Value of equity= FCFE1/(Ke-g)= 291,926.48 g= growth rate in equity forever= 5% Ke= Cost of equity= Return on capital + (Debt/Equity)*(Return on capital-after tax cost of debt) So, ke= 13.42%

FCFE= Workings: Given,

23,400.00

MPRs balance sheet

Assets Operating Current Assets Total Current Assets Net PPE Total Assets Liabilities and Shareholders Equity Operating Current Liabilities Total Current Liabilities Long Term Debt Total Liabilities Total Common Equity Total Liabilities and Equity

2010

2011

2012

162,000.00 162,000.00 199,000.00 361,000.00 57,911.50 57,911.50 136,253.00 194,164.50 166,835.50 361,000.00

168,000.00 168,000.00 210,042.00 378,042.00 62,999.70 62,999.70 143,061.00 206,060.70 171,981.30 378,042.00

176,400.00 176,400.00 220,500.00 396,900.00 66,150.00 66,150.00 150,223.00 216,373.00 180,527.00 396,900.00

MPRs income statement

2010

2011

2012

Sales Costs Operating Profit Interest Expense Earnings Before Taxes Taxes Net Income Dividends

400,000.00 344,000.00 56,000.00 11,678.90 44,321.10 17,728.40 26,592.70 21,200.00

420,000.00 361,944.20 58,055.80 12,262.80 45,743.00 18,297.20 27,445.80 22,300.00

441,000.00 374,881.60 66,118.40 12,875.50 53,242.90 21,297.20 31,945.70 23,400.00

Return on capital= 9.66% After tax cost of debt= 5.14% Tax rate= 40.00% Capital expenditure= 10,458.00 Net debt issued= 7,162.00 Working Capital invested= 105,000.30 110,250.00 change in working capital= 5,249.70 FCFE=Net income-Capital exp+Net debt issued-change in working capital=

23,400.00

(b) This value of equity as per FCFE will not equal the value as per FCFF because using debt the firm value usually increases. Solution 3:(a) Given, Growth in equity=g= FCFE next year=FCFE1= Growth rate from year2=

20% $5 million 4%

No. of shares outstanding= 10 million Treasury Bills= $10 miilion Unlevered and unadjusted equity beta= 1.3 Market risk premium= 5.50% T-bond yield= 3.50% Rf+(Rm-Rf)*= Re or cost of equity= 10.65%

(b) Intrinsic value of each share stock= Value of equity/No.of outstanding shraes Value of equity= $ 86.06 million Intrinsic value of each share stock= $ 8.61 per share

that all of the other

million

ve the same estimate of value?

ost of debt)