A firm's cash flow this year was $2,000. Cash flows are expected to grow at 15% for the next three years and then taper off to a growth rate of 5% indefinitely. The firm is financed with 25% debt. The beta of the debt is 0.0, and the equity beta is 1.2. The expected return on the market is 10%, and the relevant risk-free rate is 5%.
-Refer to the information above. Calculate the terminal value at the end of year 3. Round your answer to the nearest ten dollars.

Question

Quizplus · Accepted Answer

The terminal value at the end of year 3 is calculated using the Gordon Growth Model: TV = CF3 * (1 + g) / (r - g). CF3 is the cash flow at year 3, which is $2,000 * (1.15)^3. The growth rate (g) is 5%, and the required return (r) is calculated using the CAPM: r = risk-free rate + beta * (market return - risk-free rate) = 5% + 1.2 * (10% - 5%) = 11%. Plugging these into the formula gives the terminal value.

A Firm's Cash Flow This Year Was $2,000