Heath and Logan Inc. forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13%, and the FCFs are expected to continue growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in Year 3 and beyond, what is the Year 0 value of operations, in millions? $\begin{array}{lccc}
\text { Year: } & 1 & 2&3 \
\hline \text { Free cash flaw: } & -\$ 15& \$ 10& \$ 40
\end{array}$

Question

Heath and Logan Inc. forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13%, and the FCFs are expected to continue growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in Year 3 and beyond, what is the Year 0 value of operations, in millions? $\begin{array}{lccc}
\text { Year: } & 1 & 2&3 \
\hline \text {  Free cash flaw: } & -\$ 15& \$ 10& \$ 40
\end{array}$

Quizplus · Accepted Answer

$\begin{array} { l c c c } 
\text { Year: } & 1 & 2 & 3 \
\hline \text { FCF: } & - \$ 15 & \$ 10 & \$ 40
\end{array}$ 
 $\begin{array}{lr}
\mathrm{~g}:  &5\% \
\mathrm{WACC} &13\% \
\end{array}$ 
First, find the horizon, or terminal, value: HV4 = FCF3(1 + g)/(WACC σ g) = $40(1.05)/(0.13 σ 0.05) = $525 Then find the PV of the free cash flows and the horizon value: Value of operations = σ$15/(1.13) + $10/(1.13)2 + ($40 + $525)/(1.13)3 = $386

Heath and Logan Inc Year: 123 Free cash flaw: −$15$10$40\begin{array}{lccc}\text { Year: } & 1 & 2&3 \\\hline \text { Free cash flaw: } & -\$ 15& \$ 10& \$ 40\end{array} Year: Free cash flaw: ​1−$15​2$10​3$40​​

Heath and Logan Inc $\begin{array}{lccc}\text { Year: } & 1 & 2&3 \\\hline \text { Free cash flaw: } & -\$ 15& \$ 10& \$ 40\end{array}$