The free cash flows (in millions) shown below are forecast by Simmons Inc. If the weighted average cost of capital is 13% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the Year 0 value of operations, in millions?
$\begin{array} { l c c c }
\text { Year: } & 1 & 2 & 3 \
\hline\text { Free cash flow: } & - \$ 20 & 42 & \$ 45
\end{array}$
A) $586
B) $617
C) $648
D) $680
E) $714

Question

The free cash flows (in millions) shown below are forecast by Simmons Inc. If the weighted average cost of capital is 13% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the Year 0 value of operations, in millions?
$\begin{array} { l c c c } 
\text { Year: } & 1 & 2 & 3 \
\hline\text { Free cash flow: } & - \$ 20 & 42 & \$ 45
\end{array}$
A) $586
B) $617
C) $648
D) $680
E) $714

Quizplus · Accepted Answer

$\begin{array}{lccc}
\text { Year: }& {1} & 2 & 3 \
\hline\text { Free cash flow: }& -\$ 20 & \$ 42 & \$ 45
\end{array}$ 
WACC: 13% First, find the growth rate: g = $45/$42 σ 1.0 = 7.14% Second, find the horizon, or terminal, value, at Year 2: HV2 = FCF3/(WACC σ g) = $45/(0.13 σ 0.0714) = $768 Now find the PV of the FCFs and the horizon value: Value of operations = σ$20/(1.13) + ($42 + $768)/(1.13)2 = $617

The Free Cash Flows (In Millions) Shown Below Are Forecast Year: 123 Free cash flow: −$2042$45\begin{array} { l c c c } \text { Year: } & 1 & 2 & 3 \\\hline\text { Free cash flow: } & - \$ 20 & 42 & \$ 45\end{array} Year: Free cash flow: ​1−$20​242​3$45​​

The Free Cash Flows (In Millions) Shown Below Are Forecast $\begin{array} { l c c c } \text { Year: } & 1 & 2 & 3 \\\hline\text { Free cash flow: } & - \$ 20 & 42 & \$ 45\end{array}$