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Meatball is preparing a valuation of Space Force Inc (SFI) using a multiple-stage FCFE valuation model...

Meatball is preparing a valuation of Space Force Inc (SFI) using a multiple-stage FCFE valuation model with the following estimates. The FCFE per share for the current year is $1.25. The FCFE is expected to grow at 12 percent for the next four years, then at 8 percent annually for the following three years, and finally at a constant growth rate of 5 percent starting the eighth year. SFI’s estimated beta is 1.15, and Meatball believes that the current market conditions dictate a 2.50% risk free rate and a 12% expected market return. The following are five independent questions.

a) Given Meatball’s assumptions and approach, estimate the value of a share of SFI.

b) If the terminal growth rate is projected to be 6%, rather than 5%, re-estimate the value of a share of SFI. Does this new estimate make sense?

c) If the expected market return is assumed to be 9%, rather than 12%, re-estimate the value of a share of SFI. Does this new estimate make sense?

d) If the systematic risk coefficient (beta) of the stock increases from 1.15 to 1.40, re-estimate the value of a share of SFI. Does this new estimate make sense?

e) If SFI’s estimated beta is statistically insignificant, suggest an alternative approach to arrive at the required rate of return (k) on the stock and use this new k to re-estimate the value of a share of SFI. Assume SFI's bonds outstanding are traded at a yield of 6.45% and the risk premium required for SFI’s equity shareholders over bond holders is 4.25%.

Solutions

Expert Solution

a.

cost of equity, Ke 13%
Years 0 1 2 3 4 5 6 7 8
Cash flows 1.25 1.4 1.568 1.75616 1.966899 2.124251 2.294191 2.477727 30.87968
PV 1.23429579 1.218789 1.203477 1.188357 1.131519 1.0774 1.025869 11.27204
value at the end of 0 19.3517447

b.

cost of equity, Ke 13%
Years 0 1 2 3 4 5 6 7 8
Cash flows 1.25 1.4 1.568 1.75616 1.966899 2.124251 2.294191 2.477727 35.03856
PV 1.23429579 1.218789 1.203477 1.188357 1.131519 1.0774 1.025869 12.79016
value at the end of 0 20.8698643

c.

cost of equity, Ke 10%
Years 0 1 2 3 4 5 6 7 8
Cash flows 1.25 1.4 1.568 1.75616 1.966899 2.124251 2.294191 2.477727 52.29373
PV 1.27301659 1.296457 1.320329 1.344641 1.320493 1.296778 1.27349 24.43981
value at the end of 0 33.5650141

d.

cost of equity, Ke 16%
Years 0 1 2 3 4 5 6 7 8
Cash flows 1.25 1.4 1.568 1.75616 1.966899 2.124251 2.294191 2.477727 24.08901
PV 1.208981 1.169308 1.130937 1.093825 1.020148 0.951433 0.887347 7.4499
value at the end of 0 14.9118788

e.

new discount rate = 6.45%+4.25%= 11%

cost of equity, Ke 11%
Years 0 1 2 3 4 5 6 7 8
Cash flows 1.25 1.4 1.568 1.75616 1.966899 2.124251 2.294191 2.477727 45.64233
PV 1.26467931 1.279531 1.294557 1.30976 1.277814 1.246648 1.216242 20.2389
value at the end of 0 29.128129

jeff jeffy answered 1 year ago
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