Question

RTE Telecom Inc. is expected to generate a free cash flow of $167 million this year (FCF1 = $167 million), and the FCF is expected to grow at a rate of 26.20% over the following two years (FCF2 and FCF3). After the third year, however, the FCF is expected to grow at a constant rate of 4.26% per year, which will last forever. RTE Telecom Inc.'s weighted average cost of capital (WACC) is 12.78%.

Use corporate valuation method to complete your analysis:

1. You would discount the FCFs using the ____________ in your valuation.

Options: WACC / Short-run growth rate / Long-run growth rate

2. The horizon value of RTE Telecom Inc.'s cash flow is _________.

Options: $210.75 million / $3,254.69 / $277.30 million

3. The current total firm value of RTE Telecom Inc. operations is __________.

Options: $3,753.87 million / $3.321.68 million / $2,768.07 million / $499.18 million

If RTE Telecom Inc. carries $2,076 million of debt before the merger, and the firm has no nonoperating assets or preferred stock, the value of equity of RTE Telecom Inc. to Ziffy Corp. will be:

a. $392.07 million

b. $692.07 million

c. $2,076.07 million

d. $1,677.87 million

If possible, please show how to complete these types of problems in Excel. Thank you!

Answer 1

1

WACC

	WACC=	12.78%
Year	Previous year FCF	FCF growth rate	FCF current year	Horizon value	Total Value	Discount factor	Discounted value
1	0	0.00%	167		167	1.1278	148.0759
2	167	26.20%	210.754		210.754	1.27193284	165.69586
3	210.754	26.20%	265.971548	3254.718	3520.689548	1.434485857	2454.32155
	Long term growth rate (given)=	4.26%			Value of Enterprise =	Sum of discounted value =	2768.09

Where
Current FCF =Previous year FCF*(1+growth rate)^corresponding year
Unless FCF for the year provided
Total value = FCF + horizon value (only for last year)
Horizon value = FCF current year 3 *(1+long term growth rate)/( WACC-long term growth rate)
Discount factor=(1+ WACC)^corresponding period
Discounted value=total value/discount factor

Enterprise value = Equity value+ MV of debt

2768.09 = Equity value+2076

Equity value = 692.09