An analyst makes the following forecasts of cash flows for a firm with $2.5 billion of debt at the end of 2003 (in millions of dollars): 2004 2005 2006 Cash flow operations 1,439 1,726 1,994 Cash investments 539 624 734 He forecasts that free cash flows will grow at 4% per year after 2006. a)Using a required return for operations of 15%, value each of the firms 25 million outstanding shares b) Suppose that the market value of equity per share is 25% higher than the value you calculated in part. A. Assuming that the market uses the same model and agrees with the forecasted free cash flows above, what growth rate instead of 4% can justify this market price of stocks?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
An analyst makes the following
2004 2005 2006
Cash flow operations 1,439 1,726 1,994
Cash investments 539 624 734
He forecasts that
a)Using a required return for operations of 15%, value each of the firms 25 million outstanding shares
b) Suppose that the market value of equity per share is 25% higher than the value you calculated in part. A. Assuming that the market uses the same model and agrees with the forecasted free cash flows above, what growth rate instead of 4% can justify this market price of stocks?
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