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Iota Industries is an all-equity firm with 50 million shares outstanding.Iota has $200 million in cash and expects future free cash flows of $75 million per year.Management plans to use the cash to expand the firm's operations,which in turn will increase future free cash flows by 12%.Iota's cost of capital is 10% and assume that capital markets are perfect.
-The value of Iota,if they use the $200 million to expand,is closest to:

Question

Quizplus · Accepted Answer

To find the value of Iota when they use the $200 million to expand, we need to calculate the present value of the future free cash flows generated by the expansion.

The future free cash flows before expansion are $75 million per year. After the expansion, they will increase by 12%, or $9 million, to $84 million per year. We can calculate the present value of these cash flows using the perpetuity formula:

PV = CF / r

where PV is the present value, CF is the cash flow, and r is the discount rate. In this case, the cash flows are perpetuities, so we can use this formula indefinitely.

Using a discount rate of 10%, we get:

PV = $84 million / 0.10 = $840 million

Therefore, the value of Iota if they use the $200 million to expand is $840 million. This assumes that the expansion generates the expected cash flows and that the cost of capital and growth rate remain constant.

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