Question

Lawrence McKibben is preparing a valuation of Tele Norte Leste Participaces SA(NYSE.TNE), a telecom services company headquartered in Rio de Janeiro, Brazil. McKibben has decided to use a three-stage FCFE valuation model and the following estimates. The FCFE per share for the current year is $0.75. The FCFE is expected to grow at 10 percent for next year, then at 26 percent annually for the following three years, and then at 6 percent in Year 5 and thereafter. TNE's estimated beta is 2.00( remains constant) and McKibben feels that current market conditions dictate a 4.5 percent risk-free rate of return and a 5.0 percent equity risk premium. Given McKibben’s assumptions and approach. answer the following

1- what is the cost of equity for Tele Norte?

2- what is FCFE in year 1 ?

3- what is FCFE in year 4?

4- what is the terminal value at the end of year 4 ?

5- what is the current stock price of Tele Norte?

Answer 1

1 - cost of equity = risk-free rate + beta*equity risk premium

cost of equity = 4.5% + 2*5% = 4.5% + 10% = 14.5%

2 - 5

Terminal value = FCFE per share for Year 5 & beyond/(Cost of equity - constant FCFE growth rate )

Years	0	1	2	3	4	5 & beyond
Cost of equity	14.50%	14.50%	14.50%	14.50%	14.50%	14.50%
FCFE growth rate	0%	10.00%	26.00%	26.00%	26.00%	6.00%
FCFE per share	$0.75	$0.83	$1.04	$1.31	$1.65	$1.75
Terminal value	$0.00	$0.00	$0.00	$0.00	$20.58	$0.00
PV of FCFE and terminal value	$0.00	$0.72	$0.79	$0.87	$12.93	$0.00
current stock price of Tele Norte	$15.32

Calculations