The free cash flows (in millions) shown below are forecast by Parker & Sons.If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments). $$\begin{array} { l c c }
\text { Year: } & 1 & 2 \
\hline \text { Free cash flow: } & - \$ 50 & \$ 100
\end{array}$$

Question

The free cash flows (in millions) shown below are forecast by Parker & Sons.If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments). $$\begin{array} { l c c } 
\text { Year: } & 1 & 2 \
\hline  \text { Free cash flow: } & - \$ 50 & \$ 100
\end{array}$$

Quizplus · Accepted Answer

The correct answer is A.The Year 0 value of operations can be calculated using the perpetuity with growth formula:Year 0 value = FCF1 / (WACC - g)where:FCF1 = Free cash flow in Year 1 = -$50 millionWACC = Weighted average cost of capital = 11%g = Growth rate = 5%Plugging in the values, we get:Year 0 value = -$50 million / (0.11 - 0.05) = $1,456 million

The Free Cash Flows (In Millions) Shown Below Are Forecast Year: 12 Free cash flow: −$50$100\begin{array} { l c c } \text { Year: } & 1 & 2 \\\hline \text { Free cash flow: } & - \$ 50 & \$ 100\end{array} Year: Free cash flow: ​1−$50​2$100​​

The Free Cash Flows (In Millions) Shown Below Are Forecast $\begin{array} { l c c } \text { Year: } & 1 & 2 \\\hline \text { Free cash flow: } & - \$ 50 & \$ 100\end{array}$