Question

The MoMi Corporation’s cash flow from operations before interest and taxes was $2.8 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 16% of pretax cash flow each year. The tax rate is 21%. Depreciation was $340,000 in the year just ended and is expected to grow at the same rate as the operating cash flow. The appropriate market capitalization rate for the unleveraged cash flow is 12% per year, and the firm currently has debt of $4 million outstanding. Use the free cash flow approach to calculate the value of the firm and the firm’s equity. (Enter your answer in dollars not in millions.)

Answer 1

First we assumes that  cash flow from operations before interest and taxes $2.8 million is before deducting depreciation

So EBIT = $ 2.8 million - $ 340,000 = $2,460,000

FCFF = EBIT (1-t) + Depreciation = $ 2,460,000 ( 1-0.21) + $340,000 = $22,83,400

Investment by firm per year = $ 2.8 million * 16% = $448,000 per year

So net cash flow per year = $ 22,83,400 - $ 448,000 = $18,35,400

Value of firm = FCFF(1+g)/ Market Cap rate- g

= $18,35,400 (1+0.05) / 12%-5%

= $ 19,27,170 / 7%

=$ 27,531,000

Value of Debt = $ 4,000,000

Value of Equity =Value of firm - Value of debt = $ 27,531,000 - $ 4,000,000 = $ 23,531,000