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4 March, 06:13

After year 4, the free cash flows are expected to grow at an annual rate of 5%. The weighted average cost of capital for Normaltown is 12%. If the market value of the firm's debt is $100 million, find the total value of the firm's equity (common stock). a. $271.20 million b. $231.43 million c. $201.81 million d. $213.00 million

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  1. 4 March, 07:22
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    b. $231.43 million

    Explanation:

    The computation of the total value of the firm is shown below:

    But before that we need to compute the year 5 cash flow and the value of year 4 which is

    Year 5 cash flow is

    = $29 million * (1 + 0.05)

    = $30.45 million

    Now

    Value of year 4 is

    = (Year 5 cash flow) : (required rate - growth rate)

    = $30.45 million : 0.12 - 0.05

    = $30.45 million : 0.07

    = $435 million

    So, the total value of the firm is

    = $10 million : (1 + 0.12) ^1 + $15 million : (1 + 0.12) ^2 + $22 million : (1 + 0.12) ^3 + $29 million : (1 + 0.12) ^4 + $435 million : (1 + 0.12) ^4

    = $8.9286 + $11.9579 + $15.6592 + $18.430024 + $276.4504

    = $331.4260 million

    The Equity value is

    = $331.4260 million - $100 million

    = $231.43 million
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