A firm forecasts its free cash flow will be $100,000 one year from today.Free cash flows are expected to grow at 4% for the following 4 years.At the forecast horizon,the firm's growth results in an EBITDA forecast of $650,000.If its EBITDA multiple is 11 and the discount rate is 6%,what is the value of the firm?

Question

Quizplus · Accepted Answer

To find the value of the firm, we need to use the discounted cash flow (DCF) method. We can break down the steps:

1. Forecast the free cash flows for the next 5 years:

Year 1: $100,000 
Year 2: $100,000 x 1.04 = $104,000 
Year 3: $104,000 x 1.04 = $108,160 
Year 4: $108,160 x 1.04 = $112,486.40 
Year 5: $112,486.40 x 1.04 = $117,000.54

2. Calculate the terminal value using the EBITDA multiple:

Terminal value = EBITDA x EBITDA multiple 
Terminal value = $650,000 x 11 
Terminal value = $7,150,000

3. Discount the free cash flows and the terminal value to present value:

PV of free cash flows = $100,000 / (1+0.06)^1 + $104,000 / (1+0.06)^2 + $108,160 / (1+0.06)^3 + $112,486.40 / (1+0.06)^4 + $117,000.54 / (1+0.06)^5 
PV of free cash flows = $433,095.45

PV of terminal value = $7,150,000 / (1+0.06)^5 
PV of terminal value = $5,366,778.95

4. Add the present value of the free cash flows and the present value of the terminal value:

Value of the firm = PV of free cash flows + PV of terminal value 
Value of the firm = $433,095.45 + $5,366,778.95 
Value of the firm = $5,799,874.40

Therefore, the value of the firm is $5.8 million, which is option C.

A Firm Forecasts Its Free Cash Flow Will Be $100,000