Latin Beats Corporation is a firm that specializes in Spanish music and videos. In the current year, the firm reported $20 million in after-tax operating income, $15 million in capital expenditures, and $5 million in depreciation. The firm expects all three items to grow at 10% for the next five years. Beyond the fifth year, the firm expects to be in stable growth and to grow at 4% a year in perpetuity. You assume that earnings, capital expenditures, and depreciation will grow at 4% in perpetuity and that the cost of capital is 12%. (There is no working capital.) a. Estimate the terminal value of the firm at the end of the fifth year. b. What reinvestment rate and return on capital are you implicitly assuming in perpetuity when you do this? c. What would your terminal value have been if you had assumed that capital expenditures offset depreciation in stable growth? d. What return on capital are you implicitly assuming in perpetuity when you set capital expenditures equal to depreciation, while assuming growth is positive?

ANSWERS:

a. 209.37

b.0.08

c. TV=33.5/(0.12-0.04)=418.73

d.ROC= infinite

How to get the question c for the value 33.5?