Question

Cache Creek Manufacturing Company is expected to pay a dividend of $1 in the upcoming year. Dividends are expected to grow at 7% per year. The stock's current price is $20.00. Using the constant growth DDM, the market capitalization rate is _ A9% B. 12% C. 14% D. 18% The free cash flow to firm is expected to be $2 million and remains constant forever, the WACC is 10% and the cost of equity is 15%. If the market value of the debt is $5 million, what is the value of the equity? A B. C. D. $15 million $20 million $13.33 million $8.33 million

Answer 1

Question 1:

This question requires application of constant growth dividend discount model according to which: Div Po r-g Po Price of Stock Div Estimated Dividends for Next Period r = Required Rate of Return g= Growth Rate

$20 = \frac{1}{r - 0.07}$

r - 0.07 = 0.05

r = 0.12 = 12%(Option B)

Question 2:

$V_0 = \frac{FCF_1}{WACC}$

$V_0 = \frac{2}{0.10}$

This is overall firm value

Value of firm = Value of Debt + Value of Equity

20mil = 5mil + Value of Equity

Value of Equity = $15 mil (Option A)