Ellis Manufacturing Inc.has estimated FCFF for each of the next five years and believes that subsequent cash flows will grow at a constant annual rate of 3% indefinitely.If FCFF are $4,500,000 in year five,and the cost of capital is 9%,what is the value in year five of these terminal value cash flows?
A)$50,207,200
B)$75,000,000
C)$77,250,000
D)There is not enough information to answer this question.

Question

Quizplus · Accepted Answer

To calculate the terminal value in year five, we need to use the growing perpetuity formula:
Terminal Value = FCFF Year 6 / (Required Rate of Return - Growth Rate)
As given, the cash flows are expected to grow at a constant rate of 3%, so the growth rate is 3%. The cost of capital or required rate of return is 9%.
Terminal Value = $4,500,000 / (9% - 3%) = $77,250,000 
Therefore, the value of these terminal value cash flows in year five is $77,250,000, which is option C.