Argentinian Motors’ market cap is 300 billion pesos. Next year’s free cash flow is 9.6 billion pesos. Security analysts are forecasting that free cash flow will grow by 8.6% per year for the next five years.
Assume that the 8.6% growth rate is expected to continue forever. What rate of return are investors expecting?
1. Argentinian Motors has generally earned about 14% on book equity and reinvested 50% of earnings. The remaining 50% of earnings has gone to free cash flow. Suppose the company maintains the same ROE and investment rate for the long run. What will be the growth rate of earnings?
2. What would be the rate of return?