Exercise 1 (Corporate valuation) [40 marks]

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2
Your friend is looking to launch a new hotel chain, Roxy Inc., designed to serve the traveling
needs of the budget-minded millennial traveler.
To launch Roxy Inc., she is expected to invest $500 million this year (year=0). The hotel chain
is expected to generate free cash flows of $27 million per year, starting in year 1. Thereafter,
these free cash-flows are expected to grow at 3 percent per year in perpetuity. For simplicity,
assume these cash-flows are received at the end of each year.
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of the new hotel chain. To help you, she gives you the following reports for a handful of
publicly-traded firms, as well as the expected returns on the government bond (Treasury),
and the risk premium on the value-weighted market portfolio:
Company
Market
Value of
Equity
Market
Value of
Debt
Equity
Beta
Dropbox 900 150 2
Ikea 1,000 100 2.3
Intercontinental Hotels Group 7,500 2,500 1.6
10-year Treasury rate 2.0%
Expected Market Risk Premium 5.0%
Assume throughout that the CAPM holds for all assets, and that the debt of Dropbox, Ikea,
and Intercontinental Hotel Group is risk-free. None of these firms hold (excess) cash assets.
(a) If Roxy Inc. were to be 100% equity financed, what would be a reasonable estimate of
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The expected return on equity is: _B5R[\¶V:$&&LVB
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Exercise 1 (Corporate valuation) [40 marks]

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