Your company is evaluating a supplier as an acquisition target. A new analyst in your department estimated a value of $850 million for the target firm, using the following assumptions: The firm has a cost of capital of 11%. The firm is in a mature industry and will be growing at the inflation rate (2% a year) forever. The firm will not need to reinvest any of its after-tax cash flows since it is growing only at the inflation rate. As a more experienced analyst, you believe that the firm will be able to generate an excess return (a return on its capital in excess of the cost of capital) of 4% forever, and think that the estimated value for the firm is incorrect.

Part 1

What is the analyst forecasting for next year cash flow (in $ million)?

Part 2

What is the reinvestment rate necessary to achieve the given growth?

Part 3

What is the correct value of the firm (in $ million)?