Question

Sheldon Corporation projects the following free cash flows (FCFs) and interest expenses for the next 3 years, after which FCF and interest expenses are expected to grow at a constant 8% rate. Sheldon’s unlevered cost of equity is 11% its tax rate is 40%.

	Year
	1	2	3
Free cash flow ($ millions)	$20	$30	$40
Interest expense ($ millions)	$8	$9	$10

What is Sheldon’s unlevered horizon value of operations at Year 3? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places.

$ million

What is the current unlevered value of operations? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places.

$ million

What is horizon value of the tax shield at Year 3? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places.

$ million

What is the current value of the tax shield? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places.

$ million

What is the current total value of the company? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places

Answer 1

What is Sheldon’s unlevered horizon value of operations at Year 3
Unlevered horizon value at Year 3 = free cash flow at year 3*(1+g)/unlevered cost of equity - g
= $40*(1+8%)/(11%-8%) = 43.2/3% = $1,140 million.
What is the current unlevered value of operations?
Value of unlevered firm's operations = present value of free cash flows discounted at unlevered.

That implies, Unlevered value= 20/(1.11) + 30/(1.11)² + 40+1,140/(1.11)³
=18.02+ 24.35 + 862.81 = $905.18 million

What is horizon value of the tax shield at Year 3?
Tax shield horizon value = TS3(1+g)/( unlevered cost of equity -g)
5 (1.08)/(0.11-0.08) = 5.4 / 3% = 180million

What is the current value of the tax shield?
Value of the tax shield = 3.2/(1.11) + 3.6/(1.11)² + (4+180)/(1.11)³

= 2.88 + 2.92 + 134.54 = $140.34million

What is the current total value of the company?
value of Sheldon can be calculated as PV of all (FCF + Tax Shield + Horizon Value) discounted at unlevered cost of equity.
Value of sheldon = Value of unlevered firm's operations+ Value of the tax shield
= 905.18 + 140.34 = $1,045.52million