Refer to the projected financial statements for Massachusetts Stove Company (MSC) prepared for Case 10.2. The management of MSC wants to know the equity valuation implications of not adding gas stoves versus adding gas stoves under the best, most likely, and worst scenarios. Under the three scenarios from Case 10.2 and a fourth scenario involving not adding gas stoves, the projected free cash flows to common equity shareholders for Year 8 to Year 12, and assumed growth rates thereafter, are as follows:

MSC is not publicly traded and therefore does not have a market equity beta. Using the market equity beta of the only publicly traded woodstove and gas stove manufacturing firm and adjusting it for differences in the debt-to-equity ratio, income tax rate, and privately owned status of MSC yields a cost of equity capital for MSC of 13.55 percent.

Required
a. Calculate the value of the equity of MSC as of the end of Year 7 under each of the four scenarios. Ignore the midyear adjustment related to the assumption that cash flows occur, on average, over the year. Apply the growth rates in free cash flows to common equity shareholders after Year 12 directly to the free cash flow of the preceding year. (That is, Year 13 free cash flow equals the free cash flow for Year 12 times the given growth rate; Year 18 free cash flow equals the free cash flow for Year 17 times the given growth rate.)
b. How do these valuations affect your advice to the management of MSC regarding the addition of gas stoves to its woodstoveline?

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Year Worst S 47,034 $162,455 52,143 $213,895 315,633 (84,800) 48,353 S135,939 0 13-17 After Year 17 20% Growth 10% Growth 10% Growth 5% Growth 10,232 Zero Growth Zero Growth Zero Growth Zero Growth