Question

The following is a five year forecast for Tinto Wholesale Spice: ($ millions Year    1...

The following is a five year forecast for Tinto Wholesale Spice:

($ millions Year   
1 2 3 4 5
Free equity cash flow $132 $158 $190 $228 $274

The CFO estimates the company will grow at the industry growth rate of 5 percent after the fifth year, into

perpetuity. She has collected market data that indicates the current Treasury bill rate is 3 percent, the

market risk premium is 5 percent, and the beta of Tinto is 0.90.

What is the value of Tinto's common equity?

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Answer #1

Required rate = Risk free rate + beta (market risk premium)

Required rate = 0.03 + 0.9 (0.05)

Required rate = 0.075 or 7.5%

Year 6 equity cash flow = 274 * 1.05 = 287.7

Value at year 5 = CF6 / required rate - growth rate

Value at year 5 = 287.7 / 0.075 - 0.05

Value at year 5 = 287.7 / 0.025

Value at year 5 = 11,508

Value of common equity = 132 / (1 + 0.075)1 + 158 / (1 + 0.075)2 + 190 / (1 + 0.075)3 + 228 / (1 + 0.075)4 + 274 / (1 + 0.075)5 + 11,508 / (1 + 0.075)5

Value of common equity = $8,790.04

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