Question

A company expects FCF of -$15 million at Year 1 and FCF of $25 million at Year 2; after Year 2, FCF is expected to grow at a 6% rate.
If the WACC is 10%, then what is the horizon value of operations, Vop (Year 2). What is the current value of operations, Vop (Year 0)?

Answer 1

Given about a company's Free cash flows,

FCF at year 1 is FCF1 = -$15 million

FCF at year 2 is FCF2 = $25 million

after year 2, expected growth rate g = 6%

Weighted Average Cost of Capital Kc = 10%

Horizon value of company' operation at year 2 using constant dividend growth rate is

Vop at year 2, HV = FCF2*(1+g)/(Kc - g) = 25*1.06/(0.10-0.06) = $662.50 million

Current value of operation is present value of future FCFand HV discounted at Kc

=> Vop at year 0 = FCF1/(1+Kc) + FCF2/(1+Kc)^2 + HV/(1+Kc)^2

=> Vop at year 0 = -15/1.10 + 25/1.10^2 + 662.50/1.10^2 = $554.55 million