60.1K

Verified Solution

Link Copied!

$1)$ We are told in case Exhibit $1$ that MM is currently generating sales of $1\mathrm{.}5$ billion Francostan Dollars, which I$$ll still refer to as $$$$,$ hopefully without confusion. These sales generate operating profits of $$125$ million $($after expenses$).$ MM is all$-$equity financed $($so no interest charges$)$ and there are no taxes, so operating profits $($EBIT$)$ and earnings are the same thing. These are all paid out as dividends and expected to continue in perpetuity. Moreover, in Francostan nothing depreciates and there is no need for working capital so free cash flow $($FCF$)$ is simply EBIT.

FCFt $=$ EBITt$(1-$T$)$ CAPEXt $+$ DEPRt $\backslash$Delta WCt $=$ EBIT

You are also told that the prevailing risk free rate is $4\%,$ the market risk premium is $5\%,$ and MM has a $\backslash$beta of $0\mathrm{.}8.$

With all this as a backdrop, show that MM$$s stock is correctly priced at $$25/$share$.$ What is the Market$-$to$-$book ratio $($Market value of equity divided by book value of equity$)$ of MM$$s equity?

Exhibit $1$:

Income Statement

Revenue $1,500$

Operating expenses $1,375$

Operating profit $125$

Net Income $125$

Dividends $125$

Shares outstanding $62\mathrm{.}5$

Dividends per share $2\mathrm{.}00$

Balance Sheet

Current assets $450$

Fixed assets $550$

Total assets $1,000$

Book debt $0$

Book equity $1,000$

Total capital $1,000$

Answer & Explanation Solved by verified expert

See Answer