Question

Firm C is considering the acquisition of Firm T. Firm C has estimated the cash flows, cost of capital, and growth rate for firm T shown below. Answer the following questions to estimate the current value of firm T using the terminal value (aka horizon value) technique.

Cash flows, cost of capital, and growth rate for firm T

	Year 1	Year 2	Year 3	Year 4
CF	$12,100	$13,500	$16,300	$18,400

WACC = 10%, g = 3% (assumed constant following year 4).

PLEASE SHOW CALCULATIONS, I will be extremely grateful.

Q1. What is the terminal value of Firm T in Year 4?

Q2. What is the present value of the terminal value?

Q3. What is the present value of Year 1 - Year 4 cash flows?

Q4. Estimate the current value of firm T.

Answer 1

Q#1:

Terminal value in year 4= FCF4*(1+g)/(r-g)

Where

FCF4= Cash flow for year 4 (given as $18400)

g= constant growth rate after year 4 (given as 3%)

r= cost of capital or WACC (given as 10%)

Plugging the inputs, terminal value in year 4=

=18400*(1+3%)/(10%-3%) = 18952/0.07 = $270,742.86

Q#2:

Present value of terminal value(PVT)= Terminal value/(1+r)^4

= 270742.86/1.10^4 = $184921.01

Q#3:

Present value of Year 1 Cash Flow (PV1)= FCF1/(1+r)= 12100/(1+10%)= $11,000

Present value of Year 2 Cash Flow (PV2)= FCF2/(1+r)^2 = 13500/(1+10%)^2= $11,157.02

Present value of Year 3 Cash Flow (PV3)= FCF3/(1+r)^3 = 16300/(1+10%)^3= $12,246.43

Present value of Year 4 Cash Flow (PV4)= FCF4/(1+r)^2 = 18400/(1+10%)^4= $12567.45

Q#4:

Current value of firm T= PVT + PV1+ PV2+ PV3 + PV4 =

=$184,921.01 + $11,000 + $11,157.02 + $12,246.43 + $12567.45 = $231,891.92