Question
Consider a company that relies solely on equity financing; The firm has a book value of $100, as it has just been capitalized with $100.
Consider a company that relies solely on equity financing; The firm has a book value of $100, as it has just been capitalized with $100. The return on equity is projected to be 8%. The company is expected to reinvest 40% of its profits in the company. These reinvestments represent growth opportunities and earn similar returns to its current return on equity. The company will end its operations after 6 years, and anything that's left will be distributed to the shareholders. It will sell all of its assets for a one-time cash flow (assume it can do so at the book value of those assets at that time). Future cash flows will be discounted at a rate of 11%. What should this company's market-to-book ratio be?
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