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Finance:Cost of equity and value of company.

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Mr. Doe started a new retail store by using some funds accumulated in the past. The value of Mr. Doeâ??s business can be stated to be equal to the present value of the free cash flow that the retail store will generate in the future. To find out the present value of free cash flow, you need to find the discount rate (required rate of return) based on the level of risk related to Mr. Smith's retail store. To calculate adjusted discount rate, you need to use Capital Asset Pricing Model (CAPM).

The information related to discount rate and free cash flow projections is as follows:

RRF (risk free rate of return) = 4%
RM (return on market portfolio) = 12%
Ã?j (beta of the security) = 0.9

E(rj )= RRF + b(RM - RRF)

Consider the project with the following expected free cash flows:

Year Free Cash Flow
1 $3,200,000
2 3,900,000
3 2,600,000
4 4,000,000
5 9,000,000

Based on the above information, what is the required rate of return? What is the value of the company?

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Solution Summary

The problem deals with estimating the cost of equity by using the Capital asset pricing model approach and determining the value of the company.

Solution provided by:
  • B. Sc., University of Nigeria
  • M. Sc., London South Bank University
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