Problem 4.1 (modified) Problem 4.1 (modified) Consider the following data for an All-equity firm: End of Year XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX...

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Problem 4.1 (modified) Problem 4.1 (modified) Consider the following data for an All-equity firm: End of Year1 2 3 4 5 ------------------------------------------------------------------------------ (million dollars) Profit after taxes (NI) 5 6 8 10 11 Free cash flow to equity 0 0 0 5 8 Terminal value of equity 120 Stockholders required return on equity = 17% 1 (a) What is the value of equity as of the beginning of year 1? What is the initial P/E multiple (with respect to year 1 earnings) implied by your valuation? What is the P/E multiple (with respect to year 5 earnings) assumed in the estimation of the terminal value? Explain the difference between the initial and the terminal multiples. Are they comparable? (b) What is the growth rate of profit after taxes assumed for year 6 and beyond? State the assumptions needed in order to answer this question. Estimate the P/E multiple with respect to year 6 earnings. 2 Microsoft Word - Document1 Handout Problem You have been asked to evaluate the quality of investments at Gardena Inc., a firm that operates in two businesses – cement and steel. You have been provided the following information on the businesses: Book Value Market Value Unlevered beta of business Cement $500 $900 0.90 Steel $500 $600 1.20 Total $1,000 $1,500 The firm has 100 million shares, trading at $10 a share and faces a marginal tax rate of 40%. The company’s bonds have an A rating and a default spread of 2%. The riskfree rate is 4% and the equity risk premium is 5%. a. Estimate the cost of capital for the company. b. Gardena generated $ 100 million in after-tax operating income in the most recent year, estimate the economic value added (EVA) of the company. c. Gardena generated $75 million coming from the cement business and $25 million from steel. Assuming that the book values of assets did not change over the last year, estimate the economic value added (EVA) of each business separately.