Question

The free cash flows (in millions) shown below are forecast by Parker & Sons. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).

Year 1 Cash Flow -$50 Year 2 Cash Flow $100

Answer 1

We have following information provided in question -

weighted average cost of capital (wacc) =11%

growth rate after 2 years(g) = 5 %

cash flow year-1 = - $ 50

cash flow year-2 = $ 100

The value of operation at year-0 is discounted value of future FCF at WACC.

To calculate Present value of definite cash flow and perpetual growing FCF, we will use following equation -

Where,

thus,

Therefore, Value of operation -

Thus, Value of operation at Year-0 is $ 1,456.45 millions. (rounded figure)