Question 3:Equity Valuation

Milken's Way Inc. is a large company in the candy business. In the past twelve months the firm's CFO decided to change the capital structure to reap all the tax-shield benefits associated with higher debt. The firm has been enjoying a nice 10% annual growth in its FCFF. Its FCFF is expected to be $250 million next year. The growth rate is expected to be the same for an additional year after that, and then management expects the growth rate to cool down to 4.5% in perpetuity.

Milken's Way has 30 million shares outstanding. The firm's income originates mainly from its chocolate product sales but the firm also has $2600 million in non-operating cash (invested mostly in Treasury bills). Here is what the firm's capital structure looks like now:

Debt

- $2 billion in bonds due in 2040, currently yielding 5%

Equity

- $7 billion in common equity

The above amounts refer to market values. Further, 30-year Treasury bonds currently yield 2.8%, the market risk premium is 5.5%, the raw beta for Milken's Way stock is 1.6 and the firm faces a tax rate of 25%.

a. Please estimate the firm's cost of equity and cost of capital.

b. Please value the firm. Then value the equity on a per share basis (based upon the firm value).

Question 4: Dividend Discount Model

AT&T Inc is about to pay a dividend of $2.08 per share (tomorrow). Dividends are expected to grow by 2% every year. AT&T's cost of equity is 10.8% and its cost of capital is 7.6%. Based on this information, what is the value of the stock?