Question

Ergo Unlimited’s current year’s free cash flow is $10 million. It is projected to grow at 20% per year for the next five years. It is expected to grow at a more modest 5% beyond the fifth year. The firm estimates that its cost of capital is 12% during the next five years and then will drop to 10% beyond the fifth year as the business matures. Estimate the firm’s current market value.

Answer 1

V0 = [{FCF0 x (1 + g1)} / (1 + r1)] + [{FCF0 x (1 + g1)²} / (1 + r1)²] + [{FCF0 x (1 + g1)³} / (1 + r1)³] +

[{FCF0 x (1 + g1)⁴} / (1 + r1)⁴] + [{FCF0 x (1 + g1)⁵} / (1 + r1)⁵] +

[{FCF0 x (1 + g1) x (1 + gC} / {(rC - gC) x (1 + r1)⁵}]

= [{$10 x 1.20} / 1.12] + [{$10 x 1.20²} / 1.12²] + [{$10 x 1.20³} / 1.12³] + [{$10 x 1.20⁴} / 1.12⁴] +

[{$10 x 1.20⁵} / 1.12⁵] + [{$10 x 1.20⁵ x 1.05} / {(0.10 - 0.05) x 1.12⁵}]

= $10.71 + $11.48 + $12.30 + $13.18 + $14.12 + $296.51 = $358.30 million