As a finance consultant, you have advised XYZ Ltd to use the free cash flow method to value its equity. The Finance Manager of the company has advised that she estimates the free cash flows to be $5 million in one years time, $6 million in 2 years time, $7 million in 3 years time and a constant $8 million every year thereafter. The Finance Manager wishes to use a cost of equity capital of 14% per annum, but after investigation of the companys activities, you believe that 11% per annum is a more realistic cost of equity and in line with industry estimates.

(i) Using the Finance Managers estimates of future free cash flows and the cost of equity capital (14% per annum), calculate the present value of the companys equity. Answer.

(ii) Still using the Finance Managers estimates of future free cash flows, but on the assumption that your own estimate of the cost of equity capital (11% per annum) is the actual figure, calculate the amount by which the Finance Managers calculation of the present value of the companys equity is over- or under-valued.