Question

Zen Corporation forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$100 million, its FCF at t = 2 will be -$40 million and its FCF at t = 3 will be $55 million. After Year 3, FCF is expected to grow at a constant rate of 5% forever. If the weighted average cost of capital is 12%, what is the firm’s value of operations, in millions?

Answer #1

FCF1 (FCF at t=1) = - $ 100 million, FCF2 = - $ 40 million, FCF3 = $ 55 million and Growth Rate Post t= 3 is 5 % in perpetuity

FCF4 = 55 x 1.05 = $ 57.75 million, Weighted Average Cost of Capital (WACC) = 12 %

Terminal Value of Perpetual FCFs at the end of Year 3 (t=3) = FCF4 / 9WACC - g) = 57.75 / (0.12 - 0.05) = $ 825 million

Value of Operations = Sum of Present Values of FCF1, FCF2, FCF3 and Terminal Value of Perpetual FCFs = - 100 / (1.12) + (-40) / (1.12)^(2) + 55 / (1.12)^(3) + 825 / (1.12)^(3) = $ 505.193 million

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