Question

he MoMi Corporation’s cash flow from operations before interest and taxes was $1.8 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 18% of pretax cash flow each year. The tax rate is 21%. Depreciation was $240,000 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 11% 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.

1) whats the value of firm ?

2) whats the value of firm's equity?

Answer 1

1). Before-tax and interest cash flow from operations $1,890,000

(-) Depreciation 252,000

Taxable Income 1,638,000

(-) Taxes (@ 21%) 343,980

After-tax unleveraged income 1,294,020

After-tax cash flow from operations

(After-tax unleveraged income + depreciation) 1,546,020

New investment (18% of cash flow from operations) 340,200

Free cash flow

(After-tax cash flow from operations - new investment) $1,205,820

The value of the firm (i.e., debt plus equity) is:

V0 = C1 / (k - g) = $1,205,820 / (0.11 - 0.05) = $1,205,820 / 0.06 = $20,097,000

2). Since the value of the debt is $4 million,

Value of the equity = $20,097,000 - $4,000,000 = $16,097,000.