River Walk Tours is expected to have an EBIT of $184,000 next year. Depreciation, the increase in net working capital, and capital spending are expected to be $11,000, $1,500, and $13,000, respectively. All are expected to grow at 6 percent per year for three years. After Year 4, the adjusted cash flow from assets is expected to grow at 2.5 percent indefinitely. The company's WACC is 9.2 percent and the tax rate is 21 percent. What is the terminal value of the company's cash flows?

Question

Quizplus · Accepted Answer

To calculate the terminal value, we need to use the formula:

Terminal Value = (FCFn x (1 + g)) / (WACC - g), 
where FCFn is the free cash flow at the end of Year 4, g is the growth rate after Year 4, and WACC is the weighted average cost of capital.

First, we need to calculate the free cash flow at the end of Year 4, which is:
FCF4 = EBIT*(1-T) + Depreciation - Capital Spending - Increase in NWC
FCF4 = $184,000*(1-0.21) + $11,000 - $13,000 - $1,500
FCF4 = $134,710

Next, we can calculate the terminal value:
Terminal Value = (FCF4 x (1 + g)) / (WACC - g)
Terminal Value = ($134,710 x (1 + 0.025)) / (0.092 - 0.025)
Terminal Value = $2,584,798

Therefore, the best choice is B) $2,584,798.

River Walk Tours Is Expected to Have an EBIT of $184,000