Misra Inc. forecasts a free cash flow of $35 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5.5% thereafter. If the weighted average cost of capital (WACC) is 10.0% and the cost of equity is 15.0%, what is the horizon, or terminal, value in millions at t = 3?

Question

Quizplus · Accepted Answer

The correct answer is A.The horizon value is the present value of the FCFs beyond the explicit forecast period. In this case, the explicit forecast period is Year 3, so the horizon value is the present value of the FCFs from Year 4 onwards.The FCFs from Year 4 onwards are expected to grow at a constant rate of 5.5%. Therefore, the horizon value can be calculated using the Gordon growth model:Horizon value = FCF4 / (WACC - g)where:FCF4 = FCF3 * (1 + g)g = growth rateWACC = weighted average cost of capitalSubstituting the given values into the formula, we get:Horizon value = $35 million * (1 + 0.055) / (0.100 - 0.055)= $35 million * 1.055 / 0.045= $821 millionTherefore, the horizon value in millions at t = 3 is $821 million.

Misra Inc Forecasts a Free Cash Flow of $35 Million in in Year