Homework Help: investing

Posted by Gregg on Saturday, March 14, 2009 at 7:20pm.

Gregg graduated several years ago with his MBA. He founded Alpha Industries upon graduation and has worked hard to build the business. In the year that just ended, Alpha’s free cash flow was negative $10 million due to a significant capital expenditure. Alpha expects to realize free cash flow of negative $5 million in one year, $0 (zero) in two years, and positive $5 million in three years. After three years, free cash flow is expected to grow at a constant rate forever.

Gregg just received an offer for his company from a private equity firm. He is tempted to take the offer but he wants to understand how the offer price was determined. In particular, he is trying to estimate the long-term constant growth rate in free cash flow. Assume that the required return is 16%. If Gregg was just offered $50 million for his business, determine the constant growth rate in free cash flow after three years that would justify this offer price.

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