Kedia Inc.forecasts a negative free cash flow for the coming year,FCF₁ = −$10 million,but it expects positive numbers thereafter,with FCF₂ = $25 million.After Year 2,FCF is expected to grow at a constant rate of 4% forever.If the weighted average cost of capital is 14.0%,what is the firm's total corporate value,in millions?

Question

Quizplus · Accepted Answer

The correct answer is B. The total corporate value is the sum of the present value of the future cash flows. The present value of the future cash flows is calculated as follows:PV = FCF1 / (WACC - g) + FCF2 / (WACC - g)^2 + FCF3 / (WACC - g)^3 + ...where:PV is the present valueFCF is the free cash flowWACC is the weighted average cost of capitalg is the growth rateIn this case, the FCF for the coming year is -$10 million, the FCF for Year 2 is $25 million, and the FCF is expected to grow at a constant rate of 4% forever. The WACC is 14.0%.Therefore, the present value of the future cash flows is:PV = -$10 million / (0.14 - 0.04) + $25 million / (0.14 - 0.04)^2 + $25 million * (1.04) / (0.14 - 0.04)^3 + ...= -$10 million / 0.10 + $25 million / 0.10^2 + $25 million * 1.04 / 0.10^3 + ...= -$100 million + $250 million + $260 million + ...= $210.53 millionTherefore, the total corporate value is $210.53 million.

Kedia IncForecasts a Negative Free Cash Flow for the Coming Year,FCF1

Kedia IncForecasts a Negative Free Cash Flow for the Coming Year,FCF₁