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

The discount rate or cost of equity will be the expected rate of return as per CAPM model.

Rf + beta*(Rm – Rf)
=> 4% + 1.5*(6%) = 13%

Expected Dividends:

D1 = $1.5 x 1.20 = $1.8
D2 = $1.8 x 1.20 = $2.16
D3 = $2.16 x 1.20 = $2.592
D4 = $2.592 x 1.20 = $3.11

Present value of dividends:

D1 = $1.8/(1.13) = $1.59292
D2 = $2.16/(1.13)2 = $1.69159
D3 = $2.592/(1.13)3 =$1.79638
D4 = $3.11/(1.13)4 = $1.90742

Current Equity Value = Sum of present value of all dividends = $6.988324454 or $6.99

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