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Use the information for the question(s) below. Flagstaff Enterprises is expected to have free cash flow...

Use the information for the question(s) below. Flagstaff Enterprises is expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket. If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as a levered firm is closest to: A. $111 million B. $100 million C. $114 million D. $140 million

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Answer #1

Weight of Debt is calculated as

= 0.3333

Weight of Equity = 1-Weight of Debt

= 1-0.3333

= 0.6667

WACC = Cost of Equity*Weight of Equity + Cost of Debt* Weight of Debt*(1-Tax rate)

= 13*0.66667 + 7*0.33333*(1-0.35)

= 10.1833%

Value of Firm = FCF1/(r-g)

Where, FCF1 is the expected free cash flow at time 1

r is the required return

g is growth rate

Value of Firm = $8million/(0.101833-0.03)

= $111.835 million

Since value of Flagstaff as a levered firm is closest to $111 million, the correct option is A.

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