The free cash flow to the firm is $300 million in perpetuity,the cost of equity equals 14% and the WACC is 10%.If the market value of the debt is $1.0 billion,what is the value of the equity using the free cash flow valuation approach?

Question

Quizplus · Accepted Answer

Using the free cash flow valuation approach, the value of the firm is calculated as follows:

Value of the firm = Free Cash Flow to the Firm / (WACC - growth rate)

Since the free cash flow to the firm is given as $300 million in perpetuity, the growth rate is zero. Therefore, the value of the firm is:

Value of the firm = $300 million / (10% - 0%)

Value of the firm = $3 billion

Now, to find the value of equity, we subtract the market value of debt from the value of the firm:

Value of equity = Value of the firm - Market value of debt

Value of equity = $3 billion - $1 billion

Value of equity = $2 billion

Therefore, the value of the equity using the free cash flow valuation approach is $2 billion. The correct answer is B).

The Free Cash Flow to the Firm Is $300 Million