Consider the following data:
FCF₁ = $20 million; FCF₂ = $20 million; FCF₃ = $20 million. Assume that free cash flow grows at a rate of 5 percent for year 4 and beyond. If the weighted average cost of capital is 12 percent, calculate the value of the firm.

Question

Quizplus · Accepted Answer

First we need to calculate the present value of cash flows for years 1 to 3 using the formula:
PV = CF / (1 + WACC)^t

For year 1: PV = 20 / (1 + 0.12)^1 = $17.86 million
For year 2: PV = 20 / (1 + 0.12)^2 = $15.93 million
For year 3: PV = 20 / (1 + 0.12)^3 = $14.24 million

Now we need to calculate the present value of the cash flows from year 4 and beyond using the perpetuity formula:
PV = CF / r

Where CF is the cash flow in year 4 and r is the WACC minus the growth rate. So:
PV = 20 * 1.05 / (0.12 - 0.05) = $300 million

Adding up all the present values, we get:
PV = 17.86 + 15.93 + 14.24 + 300 = $348.03 million

Therefore, the value of the firm is $261.57 million (rounded to two decimal places).

Consider the Following Data