Motor Homes Inc. (MHI) is presently enjoying abnormally high growth because of a

Question

Motor Homes Inc. (MHI) is presently enjoying abnormally high growth because of a surge in the demand for motor homes. The company expects free cash flow to grow at a rate of 20% for the next 4 years, after which there will be no growth (g = 0) in FCFF. The company’s last FCFF, FCFF0, was $1.50. The firm is consisted of 100% equity and has no debt. MHI’s beta is 1.5, the market risk premium is 6%, and the risk-free rate is 4%. Given there’s no debt, what is the current equity value of the firm using DCF model?

Explanation / Answer

Cost of capital=4+1.5*6=4+9=13%

Equity Value=1.5 +1.5*1.2/1.13 +1.5*(1.2^2)/1.13^2 +1.5*(1.2^3)/1.13^3 +1.5*(1.2^4)/1.13^4 +1.5*(1.2^4)/(0.13*1.13^4)

=23.16

Equity value= FCFF0 +PV(FCFF1)+PV(FCFF2)+PV(FCFF3)+PV(FCFF4)+PV(Terminal value)

since growth rate is 0 beyond 4 years hence FCFF at 4th year will be divided by cost of capital to achieve terminal value=FCFF0*(1.20^4)/0.13

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