Question

Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows...

Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows for this division for the next five​ years, and have estimated that the cost of capital is 12%. You would like to estimate a continuation value. You have made the following forecasts for the last year of your​ five year forecasting horizon​ (in millions of​ dollars):

Year 5

Revenues

​ 1,200.0

Operating income

100.0

Net income                             

50.0

Free cash flows

                                                

110.0

Book value of equity

400.0

a. You forecast that future free cash flows after year 5 will grow 2% per​ year, forever. Estimate the continuation value in year​ 5, using the perpetuity with growth formula.

b. You have identified several firms in the same industry as your operating division. The average​ P/E ratio for these firms is 30. Estimate the continuation value assuming the​ P/E ratio for your division in year 5 will be the same as the average​ P/E ratio for the comparable firms today.

c. The average​ market/book ratio for the comparable firms is 4.0. Estimate the continuation value using the​ market/book ratio.

Note​:

Assume that all firms​ (including yours) have no debt.

*Make sure to round to one decimal place*

Business   Finance   
0 0
Add a commentTranscribed image text
Next >

Homework Answers

Answer #1

a. continuation value in year​ 5 = free cash flow year 5*(1+free cash flow growth rate)/(cost of capital - free cash flow growth rate)

continuation value in year​ 5 = 110*(1+0.02)/(0.12 - 0.02) = (110*1.02)/0.10 = 112.2‬/0.10 = 1,122‬.0

b. P/E ratio = Price/earnings or net income

average​ P/E ratio for the industry is 30 and for your division in year 5 will be the same as the average​ P/E ratio for the comparable firms today.

30 = Price/50

Price = 30*50 = 1,500‬.0

continuation value in year​ 5 using P/E ratio is 1,500.0.

c. market/book ratio = market value/book value

The average​ market/book ratio for the comparable firms is 4.0.

4 = market value/400

market value = 4*400 = 1,600‬.0

the continuation value using the​ market/book ratio is 1,600‬.0.

0 0
Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Log In

Sign Up

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
You are evaluating a firm with projected free cash flows given below. You expect that cash...
You are evaluating a firm with projected free cash flows given below. You expect that cash flows will grow by 4% per year after the forecast period. The appropriate discount rate is 12%. The firm has a net income of $34 million. Debt of $20 million. The firm has 10 million shares outstanding. You have found a comparable firm with a P/E multiple of 11.5 times. What is the price per share of the firm using FCF discounted by weighted...
1. Calculating project cash flows: Why do we use forecasted incremental after-tax free cash flows instead...
1. Calculating project cash flows: Why do we use forecasted incremental after-tax free cash flows instead of forecasted accounting earnings in estimating the NPV of a project? 2. The FCF calculation: How do we calculate incremental after-tax free cash flows from forecasted earnings of a project? What are the common adjustment items? 3. The FCF calculation: How do we adjust for depreciation when we calculate incremental after-tax free cash flow from EBITDA? What is the intuition for the adjustment? 4....
Heavy Metal Corporation is expected to generate the following free cash flows over the next five...
Heavy Metal Corporation is expected to generate the following free cash flows over the next five years: Year 1 2 3 4 5 FCF ($millions) 53 68 78 75 82 After then, the free cash flows are expected to grow at the industry average of 4% per year (continuation value). Using the discounted free cash flow model and a weighted average cost of capital of 14%, estimate the approximate share price for Heavy Metal if the firm has $50 million...
A company has a proposed 2-year project with the cash flows shown below and would like...
A company has a proposed 2-year project with the cash flows shown below and would like to calculate the NPV of this project so that they can decide whether to pursue the project or not. The company has a target capital structure of 60% equity and 40% debt. The beta for this firms stock is 1, the risk-free rate is 4.2, and the expected market risk premium is 5.8%. The bonds for this company pay interest semiannually and have a...
You have been asked to evaluate the proposed acquisition of a new portable MRI. The system’s...
You have been asked to evaluate the proposed acquisition of a new portable MRI. The system’s price is $70,000 and it will cost another $20,000 for transportation and installation the system is expected to be sold after three years because a new stationary machine will be acquired at that time the best estimate of the system salvage value after three years is $30,000 the system will have no impact on volume or reimbursement (and hence revenues) but it is expected...
You forecast the free cash flows for your target firm over the next five years. The...
You forecast the free cash flows for your target firm over the next five years. The final cash flow, at the end of year five, is projected to be $200 million. Assuming a FCF terminal growth rate of 3% and an overall discount rate of 12%, what is the present valueof all future cash flows after the planning period? (Hint: do not forget to discount to today.)
You have been asked to evaluate the proposed acquisition of a new clinical laboratory test system....
You have been asked to evaluate the proposed acquisition of a new clinical laboratory test system. The system's price is $50,000 and it will cost another $10,000 for transportation and installation. The system is expected to be sold after three years because the laboratory is being moved at that time. The best estimate of the system's salvage value after three years of use is $20,000. The system will have no impact on volume or reimbursement (and hence revenues), but it...
Your company has 2 divisions: One division sells software and the other division sells computers through...
Your company has 2 divisions: One division sells software and the other division sells computers through a direct sales channel, primarily taking orders over the web. You have decided that Dell Computer is very similar to your computer division, in terms of both risk + financing. You go online and find the following info: Dells beta is 1.21, the risk-free rate is 4.5%, its market value of equity is $67 billion, and it has $700 million worth of debt with...
Citric's managers believe that it will have the following free cash flows. If the weighted average...
Citric's managers believe that it will have the following free cash flows. If the weighted average cost of capital is 14% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3. If there is $200 million in debt, $30 million in preferred stock, and 10 million shares outstanding, what is your estimate of stock price? Year 1 2 3 Free cash flow -$20.00 $48.00 $50.50 ​...
The XYZ Company has a historical growth in its free cash flows of 4% with little...
The XYZ Company has a historical growth in its free cash flows of 4% with little variability. With the addition of a new plant and equipment, however, you expect that free cash flows will grow 7% in year 1, 5% in year 2, and 5% thereafter. The firm’s last free cash flow was $175,000. The firm has a required rate of return of 10%. The book value of operating assets is $1,000,000. The market value of non-operating assets is $900,000....
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT