Question

The MoMi Corporation’s cash flow from operations before interest, depreciation and taxes was $1.5 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 15% of pretax cash flow each year. The tax rate is 21%. Depreciation was $210,000 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 $3 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

Answer :

Calculation :

C/F from Operations before interest and tax = Last year C/F from Operations before interest and tax + 5% growth
= $1,500,000 + ($1,500,000 * 5%)
= $1,575,000

Depn = $210,000 + ($210,000 * 5%) = $220,500

Taxable income = $1,575,000 - $220,500 = $1,354,500

After Tax unleveraged income = $1,354,500 * (1 - 21%) = $1,070,055.

After Tax C/F from Operation = $1,070,055 + $220,500 = $1,290,555

Fresh Investment at 15% of C/F from operation = $1,575,000 * 15% = $236,250

FCF = $1,290,555 - $236,250 = $1,054,305

Present value of all future FCF = $1,054,305 / (12% - 5%)
= $15,061,500

Equity value = firm value – market value of debt

Value of equity = $15,061,500 - $3,000,000 = $12,061,500.