McCaw Cellular Communications reported earnings before interest and taxes of \($850\) million in 1993, with a depreciation allowance of

\($400\) million and capital expenditures of \($550\) million in that year; the working capital requirements were negligible. The earnings before interest and taxes and net cap ex are expected to grow 20% a year for the next five years. The cost of capital is 10% and the return on capital is expected to be 15% in perpetuity after year 5; the growth rate in perpetuity is 5%. The firm has \($10\) billion in debt outstanding with the following characteristics:

The annualized standard deviation in the firm’s stock price is 35%, while the annualized standard deviation in the traded bonds is 15%. The correlation between stock and bond prices has been 0.5, and the average debt ratio over the past few years has been 60%. The three-year bond rate is 5%, and the tax rate is 40%.

a. Estimate the value of the firm.

b. Estimate the value of the equity.

c. The stock was trading at \($30,\) and there were 210 million shares outstanding in January 1994. Estimate the implied standard deviation in firm value.

d. Estimate the market value of the debt.

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Duration Debt 1 year $2 billion