Question

The MoMi Corporation’s income before interest, depreciation and taxes, was $2.7 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 30%. Depreciation was $330,000 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 $5 million outstanding. Use the free cash flow approach to calculate the value of the firm and the firm’s equity.

Value of the firm	$ ??
Value of the firm's equity	$ ??

Answer 1

Value of the firm	$2,37,60,000
Value of the firm's equity	$1,87,60,000

Value of Firms Equity using free cash flow approach

Particulars	Amount ($)
Cash flow from operations before interest and taxes [$27,00,000 x 105%]	28,35,000
Less: Depreciation Expenses [$330,000 x 105%]	3,46,500
Taxable Income	24,88,500
Less: Tax at 30% [$24,88,500 x 30%]	7,46,550
After-tax unleveraged income	17,41,950
Add Back: Depreciation Expenses	3,46,500
Net Income after tax	20,88,450
Less: Additional Investment [$38,35,000 x 15%]	4,25,250
Free Cash Flow (FCF)	16,63,200

Total Value of the firm

Free Cash Flow (FCF) = $16,63,200

Growth Rate per year (g) = 5% per year

Required Rate of Return (Ke) = 12% per year

Total Value of the firm = Free cash flow / (market capitalization rate – Growth Rate)

= FCF / (Ke – g)

= $16,63,200 / (0.12 – 0.05)

= $16,63,200 / 0.07

= $2,37,60,000

Value the firm’s Equity

Value the firm’s Equity = Total Value of the firm – Market Value of Debt

= $2,37,60,000 - $50,00,000

= $1,87,60,000