Question

Neil’s Surf shop had firm-free cash flow of $33,000 last year (year 0), which is expected to grow at 5% a year for the next five years, after which it will grow at 2% for eternity. The appropriate cost of equity is 15%. The surf shop has no debt or notable cash on hand. Use a simple discounted cash flow (DCF) analysis to value the surf shop. What is the present value of this company?

A 190,929.16

B 290,929.16

C 390,929.16

D 490,929.16

Answer 1

Year 1 cash flow = 33,000 * 1.05 = 34,650

Year 2 cash flow = 34,650 * 1.05 = 36,382.5

Year 3 cash flow = 36,382.5 * 1.05 = 38,201.625

Year 4 cash flow = 38,201.625 * 1.05 = 40,111.70625

Year 5 cash flow = 40,111.70625 * 1.05 = 42,117.29156

Year 6 cash flow = 42,117.29156 * 1.02 = 42,959.63739

Value at year 5 = FCF6 / required rate - growth rate

Value at year 5 = 42,959.63739 / 0.15 - 0.02

Value at year 5 = 42,959.63739 / 0.13

Value at year 5 = 330,458.7492

Present value of company = 34,650 / (1 + 0.15)¹ + 36,382.5 / (1 + 0.15)² + 38,201.625 / (1 + 0.15)³ + 40,111.70625 / (1 + 0.15)⁴ + 42,117.29156 / (1 + 0.15)⁵ + 330,458.7492 / (1 + 0.15)⁵

Present value of company = 290,929.16