Problem
GROWMORE is engaged in the dairy foods business for more than 21 years. Currently, the firm has a return on capital of 26 percent and reinvests 58 percent of its earnings back into the firm. In its recent financial statements, the firm has reported an operating income of $232 million. The cost of capital for the company is 14.62 percent. Analysts are anticipating that the current expected growth rate of this firm will continue for the next 7 years. The growth rate is expected to drop to 4.44 percent after year 7 but the return on capital is expected to remain the same.
• Requirement-A: Calculate the terminal value in the year 7 and the value of the firm.
• Requirement-B: If the return on capital changed in stable growth to 15 percent after year 7. while keeping the growth rate at 4.44 percent, what would be the value of the firm?
• Requirement-C: Considering the effect of changing the reinvestment rate to 41 percent in the year 7, and changing the growth rate to 3.36 percent while keeping the return on capital unchanged at stable growth, what would be the value of the firm now?
• Requirement-D: How does the above value change by changing the growth rate and reinvestment rate to 0% in the year 7, while keeping the return on capital unchanged (as per req. c) in stable growth?
• Requirement-E: Comment on the findings.