7–17. In the year in which it intends to go public, a firm has revenues of $20 million and net income after taxes of $2 million. The firm has no debt, and revenue is expected to grow at 20 percent annually for the next five years and 5 percent annually thereafter. Net profit margins are expected to remain constant throughout. Annual capital expenditures equal depreciation, and the change in working capital requirements is minimal. The average beta of a publicly traded company in this industry is 1.50 and the average debt-to-equity ratio is 20 percent. The firm is managed conservatively and will not borrow through the foreseeable future. The Treasury bond rate is 6 percent, and the tax rate is 40 percent. The normal spread between the return on stocks and the risk-free rate of return is believed to be 5.5 percent. Reflecting the slower growth rate in the sixth year and beyond, the discount rate is expected to decline to the industry average cost of capital of 10.4 percent. Estimate the value of the firm’s equity.

Answer: $63.41 million.