Refer to the financial statement forecasts for Massachusetts Stove Company (MSC) prepared for Case 10.2. The management of MSC wants to know the equity valuation implications of adding gas stoves under the best, most likely, and worst case scenarios. Under the three scenarios from Case 10.2, the actual amounts of net income and common shareholders’ equity for Year 7 and the projected amounts for Year 8–Year 12 are as follows:

MSC is not publicly traded and therefore does not have a market equity beta. Using the market equity beta of the only publicly traded woodstove and gas stove manufacturing firm and adjusting it for differences in the debt-to-equity ratio, income tax rate, and privately owned status of MSC yields a cost of equity capital for MSC of 13.55 percent.

Required

a. Use the clean surplus accounting approach to derive the projected total amount of MSC’s dividends to common equity shareholders in Years 8 through 12.

b. Given that MSC is a privately held company, assume that ending book value of common equity at the end of Year 12 is a reasonable estimate of the value at which the common shareholders’ equity could be liquidated. Calculate the value of the equity of MSC as of the end of Year 7 under each of the three scenarios. Ignore the midyear discounting adjustment.

c. How do these valuations affect your advice to the management of MSC about adding gas stoves to its woodstove line?

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Actual Projected Year 7 Year 8 Year9 Year 10 Year Year 12 Best-Case Scenario: Net Income Common Equity Most Likely Scenario: Net Income Common Equity Worst-Case Scenario: Net Income Common Equity $154,601 $148,422 $123,226 $173,33 271,725 $ 390,639 $552,080 $700,502 $823,728 $997,064 $1,268,789 $1,659,429 $154,601 S$135,343 S 74,437 72,899 109,357 $ 149,977 $552,080 $687,423 $761,860 $834,759 944,116 $1,094,093 $154,601 S$128,263 S 18,796 $(39,902) S (58,316) S (77,156) $552,080 $680,343 S699,139 $659,238 600,921 S 523,766