7–14. In 2002, No Growth Incorporated had operating income before interest and taxes of $220 million. The firm was expected to generate this level of operating income indefinitely. The firm had depreciation expense of $10 million that year. Capital spending totaled $20 million during 2002. At the end of 2001 and 2002, working capital totaled $70 million and $80 million, respectively. The firm’s combined marginal state, local, and federal tax rate was 40 percent, and its debt outstanding had a market value of $1.2 billion. The 10-year Treasury bond rate is 5 percent, and the borrowing rate for companies exhibiting levels of creditworthiness similar to No Growth is 7 percent. The historical risk premium for stocks over the risk-free rate of return is 5.5 percent. No Growth’s beta was estimated to be 1.0. The firm had 2.5 million common shares outstanding at the end of 2002. No Growth’s target debt-to-total-capital ratio is 30 percent.

a. Estimate free cash flow to the firm in 2002.

b. Estimate the firm’s weighted average cost of capital.

c. Estimate the enterprise value of the firm (i.e., includes the value of equity and debt) at the end of 2002, assuming that it will generate the value of free cash flow estimated in

(a) indefinitely.

d. Estimate the value of the equity of the firm at the end of 2002.

e. Estimate the value per share at the end of 2002.

Answers:

a. $112 million.

b. 8.61 percent.

c. $1,300.8 million.

d. $100.8 million.

e. $40.33.