Question

home / study / business / finance / finance questions and answers / suppose the expected free cash flow for year 1 is $250,000 but it is expected to grow unevenly ... Question: Suppose the expected free cash flow for Year 1 is $250,000 but it is expected to grow unevenly ov... Suppose the expected free cash flow for Year 1 is $250,000 but it is expected to grow unevenly over the next 3 years: FCF2 = $290,000 and FCF3 = $320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is $80,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be $95,000, at Year 3 it will be $120,000 and it will grow at 7% thereafter. Please use these numbers: Tax Rate: Firm U = 40%, Firm L = 14% Value of Firm: Firm U = 3,571,429, Firm L = 3,571,429 Value of Equity: ​Firm U = 3,571,429 , Firm L = 2,571,429 Levered Cost of Equity: = 16.33% ​WACC = 14%

What is the current total value? Please show how you came to that number.

The tax rate and unlevered cost of equity remain at 40% and 14% respectively.

Answer 1

In the given question, there are two types of firm:

1. firm with no debt

2. firm with debt

For Firm 1

Free Cash flow value	250000
Tax @ 40 %	100000
Free cash flow net of tax	150000

Levered cost of equity 16.33%

Thus, Value of firm = Free cash flow net of tax/Cost of equity

= 150000/16.33%

= 918555

2. Firm with debt

	Year 1	Year 2	Year 3	Year to infinity
Free Cash flow value	250000	290000	320000	342400
less: Interest expenses	80000	95000	120000	128400
Free Cash flow value	170000	195000	200000	214000
Tax @ 40 %	68000	78000	80000	85600
Free cash flow net of tax	102000	117000	120000	128400
Values to be considered	102000	117000	120000	917143
Discount rate @ 14 % Pv factor	.8772	.7695	.6750	.6750
Present Value	89474	90032	80997	619045
Current Value				879548