Question

Kendra Enterprises has never paid a dividend. Free cash flow is projected to be $80,000 and $100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 8%. The company's weighted average cost of capital is 14%.

a) What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.) Round your answer to the nearest cent.

B) Calculate the value of Kendra's operations. Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

a. The terminal value is computed as shown below:

= FCF in year 2 (1 + growth rate) / [ ( weighted average cost of capital - growth rate) ]

= $ 100,000 (1 + 0.08) / ( 0.14 - 0.08)

= $ 108,000 / 0.06

= $ 1,800,000

b. The value is computed as shown below:

= FCF in year 1 / (1 + weighted average cost of capital) + FCF in year 2 / (1 + weighted average cost of capital)² + terminal value  / (1 + weighted average cost of capital)²

= $ 80,000 / 1.14 + $ 100,000 / 1.14² + $ 1,800,000 / 1.14²

= $ 80,000 / 1.14 + $ 1,900,000 / 1.14²

= $ 1,532,163.74 Approximately

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