Answer the following questions for Canton Corporation, which was described in Problem 9-4. Assume that firm revenues grow at a rate of 10% per year during years 1 through 4 before leveling out at no growth for year 5 and beyond. You may also assume that Canton’s gross profit margin is 60%; operating expenses (before depreciation) to sales is 30%; current assets to sales is 15%; accounts payable to sales is 5%; and net property, plant, and equipment ( PPE) to sales is 40%, and that Canton maintains equal dollar amounts of long-term debt and equity to finance its growing needs for invested capital. Also assume that the cost of unlevered equity in this case is 13.84% and the cost of levered equity is 15.28%. The cost of debt remains at 8%. The corporate tax rate is 30%.
a. Calculate the enterprise value using the APV method.
b. From (a), calculate the value of equity after deducting the value of book debt from enterprise value. Use the market value of equity and book value of debt as weights to compute WACC.
c. Value the firm’s FCFs using the WACC approach.
d. Compare your enterprise-value estimates for the two discounted cash flow models. Which of the two models do you feel best suits the valuation problem posed for Canton?