Your company operates a toy factory, which is all-equity financed. Next year, it

Question

Your company operates a toy factory, which is all-equity financed. Next year, it is estimated that the toy factory will generate $30 million of sales revenue; historically, operating costs have been consistently 60% of sales revenue. After next year, the revenue is expected to grow at a constant rate of 3% per year forever. If the toy factory has an asset beta of 1.2, what is value of the toy factory The risk-free rate of return is 2%, the expected return on the market portfolio is 7%, and the corporate tax rate is 4 0%.

Explanation / Answer

1st year

$30 million = sales

$18 million = cost

Therefore operating profit = 30-18= $12 million

Profit after tax= 12(1-0.40) = $7.2 million.

After one year constant growth model

30(1.03) = 30.90 = sales

Cost= 30.90*0.60 = 18.54

Therefore operating profit = $12.36 million forever

Profit after tax= 12.36(1-0.40)= 7.416

We can calculate the value of company through discount ed cash flow

We require cost of equity which can be calculate through CAPM model:

Ke = Rf + beta (Rm – Rf)

     = 2+1.2(7-2)

     = 8%

Now, calculating the value of the firm through DCF:

7.2/ (1+0.08) ^1 + 7.416 / (8 – 3)

6.7 + 148.32 = $154.99 million. Answer

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