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?

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?
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? A) $315 B) $331 C) $348 D) $367 E) $386

Quizplus · Accepted Answer

11ea1b84_8ba4_393e_a54a_53d1a9ecc578_TB3581_00 
 11ea1b84_8ba4_604f_a54a_8778e43bf501_TB3581_00 
First, find the horizon, or terminal, value:
HV? = FCF?(1 + g)/(WACC - g)= $40(1.05)/(0.13 - 0.05)= $525
Then find the PV of the free cash flows and the horizon value:
Value of operations = -$15/(1.13)+ $10/(1.13)² + ($40 + $525)/(1.13)³ = $386