The income statements for Infonext Corporation for 2007 and 2008 are provided below:
-Refer to the information above. Assume sales will grow at the same rate as they did last year and that depreciation is expected to increase to $850 and interest expense to $1,370. Also
Assume the tax rate will remain a flat 40% in 2009. Gross plant, property, and equipment is
Expected to increase by 6.8% and will be the only investment cash flow. Infonext's additional
Investment in net working capital is expected to be 2% of the change in sales. The cost of capital
Is 14%, and Infonext's 2009 cash flows are expected to remain at that level forever. Calculate
Infonext's terminal value at the end of 2009. Round your answer to the nearest thousand
Dollars.

Question

The income statements for Infonext Corporation for 2007 and 2008 are provided below: 
-Refer to the information above. Assume sales will grow at the same rate as they did last year and that depreciation is expected to increase to $850 and interest expense to $1,370. Also
Assume the tax rate will remain a flat 40% in 2009. Gross plant, property, and equipment is
Expected to increase by 6.8% and will be the only investment cash flow. Infonext's additional
Investment in net working capital is expected to be 2% of the change in sales. The cost of capital
Is 14%, and Infonext's 2009 cash flows are expected to remain at that level forever. Calculate
Infonext's terminal value at the end of 2009. Round your answer to the nearest thousand
Dollars.

Quizplus · Accepted Answer

The correct answer is A.The terminal value is the present value of all future cash flows beyond the explicit forecast period. In this case, the explicit forecast period is 2009. The terminal value is calculated as follows:Terminal value = (FCF / (r - g)) * (1 + g)where:FCF = free cash flowr = cost of capitalg = growth rateThe free cash flow is calculated as follows:FCF = EBIT * (1 - tax rate) + depreciation - capital expenditures - change in net working capitalwhere:EBIT = earnings before interest and taxestax rate = 40%depreciation = $850capital expenditures = 6.8% of gross plant, property, and equipmentchange in net working capital = 2% of the change in salesThe growth rate is assumed to be the same as the growth rate in sales, which is not given in the question. However, we can assume that sales will grow at a constant rate of 5%.The cost of capital is given as 14%.Plugging in the numbers, we get:FCF = $10,000 * (1 - 0.4) + $850 - $1,000 - $200 = $6,650Terminal value = $6,650 / (0.14 - 0.05) * (1 + 0.05) = $25,586

The Income Statements for Infonext Corporation for 2007 and 2008