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Consider a growing firm that is expected to produce earnings of $10 million next year. The firm's earnings growth rates are 15% per annum. The firm's cost of capital is 20%. I ts tax rate is 0.
1: What is the market value of this firm?
2: What is the firm's P/E ratio if it has no debt?
3: Now assume that the cost of capital for debt of $100 million is 8%, while the cost of capital for the remaining levered equity is 32%. (Again, the weighted average cost of capital is 50%·8%+50%·32% = 20%, so the firm's cost of capital has not changed.) Interest on the $100 million debt is paid out. What is the equity's P/E ratio now?
4: Has the increase in debt increased or decreased the firm's P/E ratio?
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A Discounted Cash Flow Valuation (Easy) At the end of2012, you forecast the following cash flows (in millions) for a firm with net debt of $759 million.
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