Consider a firm with free cash flows to equity (FCFE) of $100 million, $160 million, and $90 million each year for years 1, 2, and 3, respectively. Assume that the first free cash flow to equity of $100 million is exactly one year away from today. Assume also that after year 3 the FCFE of the firm grows at a constant rate of 5% each year forever. Other information for the firm is as follows: Cost of Debt, RD = 10%; Unlevered Cost of Equity, 3 R0 = 15%; Tax Rate = 35%; and the firm uses 40% debt and 60% equity in its capital structure.
a. What is the appropriate discount rate at which to discount the free cash flows to equity of the firm?
b. What is the shareholder value of the firm?