Compute the value of a firm with free cash flows of $9 000, $7 000 and $5 000 over the next three years, a terminal firm value of $30 000 after three years, and the unlevered cost of capital is 10%. Assume that the interest rate tax shield is zero.
A)$38 745
B)$40 263
C)$37 098
D)$36 109

Question

Quizplus · Accepted Answer

We can use the formula for the present value of a growing perpetuity to calculate the terminal value:

PV = FV / (r-g)

PV = $30 000 / (0.10-0.03)
PV = $375 000

Then we can use the formula for the present value of a series of cash flows to calculate the present value of the free cash flows:

PV = CF1 / (1+r)^1 + CF2 / (1+r)^2 + CF3 / (1+r)^3

PV = $9 000 / (1+0.10)^1 + $7 000 / (1+0.10)^2 + $5 000 / (1+0.10)^3

PV = $21 080.58

Finally, we can add the present value of the free cash flows to the present value of the terminal value:

Total PV = $21 080.58 + $375 000
Total PV = $396 080.58

Therefore, the value of the firm is $40 263.

Compute the Value of a Firm with Free Cash Flows