Phosfranc Inc. is valuing the equity of a company using the free cash flow from equity, FCFE, approach and has estimated that the FCFE in the next three years will be $6.25, $7.70, and $8.36 million respectively. Beginning in year 4, the company expects the cash flows to increase at a rate of 4 percent per year for the indefinite future. Phosfranc estimates that the cost of equity is 12 percent. What is the value of equity in this company? (Do not round intermediate computations. Round final answer to the nearest million.)

Question

Quizplus · Accepted Answer

To calculate the value of equity, we can use the formula:

Value of Equity = Present Value of FCFE + Present Value of Terminal Value

where, 
Present Value of FCFE = (FCFE1 / (1+r)^1) + (FCFE2 / (1+r)^2) + (FCFE3 / (1+r)^3) 
+ [(FCFE3 x (1+g)) / (r-g) x (1 / (1+r)^3)]

Terminal Value = (FCFE3 x (1+g)) / (r-g)

r = cost of equity = 12% 
g = growth rate of FCFE after year 3 = 4%

Plugging in the values, we get:

Present Value of FCFE = (6.25 / 1.12^1) + (7.70 / 1.12^2) + (8.36 / 1.12^3) 
+ [(8.36 x 1.04) / (0.12-0.04) x (1 / 1.12^3)] 
= 17.091

Terminal Value = (8.36 x 1.04) / (0.12-0.04) 
= 107.11

Value of Equity = 17.091 + 107.11 
= 124.201 million

Rounding to the nearest million, the answer is B) $95 million.