Mexican Motors\' market cap is 370 billion pesos. Next year\'s free cash flow is
ID: 2703191 • Letter: M
Question
Mexican Motors' market cap is 370 billion pesos. Next year's free cash flow is 10.0 billion pesos. Security analysts are forecasting that free cash will grow by 9.0%per year for the next five years.
a. Assume that the 9.0% growth rate is expected to continue forever. What rate of return are investors expecting?
b.1. Mexican Motors has generally earned about 13% on book equity (ROE = 13%) and reinvested 50% of earnings. The remaining 50% of earnings has gone to free cash flow. Suppose the company maintains the same ROE and investment rate fr the long run. What will be the growth rate of earnings?
b.2. What would be the rate of return?
Explanation / Answer
a. Assume that the 9.0% growth rate is expected to continue forever. What rate of return are investors expecting?
Rate of Return = 10/370 + 0.09 = 0.11703 or 11.703%
b.1. Mexican Motors has generally earned about 13% on book equity (ROE = 13%) and reinvested 50% of earnings. The remaining 50% of earnings has gone to free cash flow. Suppose the company maintains the same ROE and investment rate fr the long run. What will be the growth rate of earnings?
Growth Rate = 0.5*13 = 6.5%
b.2. What would be the rate of return?
Rate of Return = 10/370 + 0.065 = 0.09203 or 9.203%