7. Your company is currently contemplating whether to buy Hot House, a national chain of computer systems consultants based in California. Your job is to estimate the market value of the equity in Hot House. To accomplish this task, you have gathered the following information. The estimated FCFF generated by Hot House for each of the next five years are as follows. CFF 1 2 3 4 5 $2,400 $2,910 $3,452 $4,452 $5,352 Subsequent to year 5, you estimate that the cash flows will grow at 6% indefinitely. Currently, the company has $5 million of debt outstanding, but that debt balance is expected to increase by 5% at the end of each year. Thus, the current debt balance of $5 million will increase to f voor $5.25 million at the and roor 1 $5 5125 million at the and Fortunately the

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Chapter1: Investments: Background And Issues
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7. Your company is currently contemplating whether to buy Hot House, a national chain of
computer systems consultants based in California. Your job is to estimate the market value of
the equity in Hot House. To accomplish this task, you have gathered the following
information. The estimated FCFF generated by Hot House for each of the next five years are
as follows.
CFF
1
$2,400
2
3
4
5
$2,910 $3,452 $4,452 $5,352
Subsequent to year 5, you estimate that the cash flows will grow at 6% indefinitely. Currently,
the company has $5 million of debt outstanding, but that debt balance is expected to increase
by 5% at the end of each year. Thus, the current debt balance of $5 million will increase to
$5.25 million at the end of year 1, $5.5125 million at the end of year 2, etc. Fortunately, the
before-tax cost of debt is expected to remain stable at 12%. Finally, you estimate that the
required return on the unlevered equity is 16%. If the company has 1 million shares
outstanding, what is the current market price per share? Assume that the company will remain
in the 34% tax bracket.
Transcribed Image Text:7. Your company is currently contemplating whether to buy Hot House, a national chain of computer systems consultants based in California. Your job is to estimate the market value of the equity in Hot House. To accomplish this task, you have gathered the following information. The estimated FCFF generated by Hot House for each of the next five years are as follows. CFF 1 $2,400 2 3 4 5 $2,910 $3,452 $4,452 $5,352 Subsequent to year 5, you estimate that the cash flows will grow at 6% indefinitely. Currently, the company has $5 million of debt outstanding, but that debt balance is expected to increase by 5% at the end of each year. Thus, the current debt balance of $5 million will increase to $5.25 million at the end of year 1, $5.5125 million at the end of year 2, etc. Fortunately, the before-tax cost of debt is expected to remain stable at 12%. Finally, you estimate that the required return on the unlevered equity is 16%. If the company has 1 million shares outstanding, what is the current market price per share? Assume that the company will remain in the 34% tax bracket.
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