Question

1- If ABC company has FCF (free cash flows) of $2,000, $3,000, and $4,000 at the end of years 1, 2, and 3. And the discount rate is 20%. Assuming the present value (PV) of the firm is $9672.50. What is its terminal value? and What is the present value of its terminal value (TV)?

2- There are 200 barrels of oil that can be extracted from a field and the price of doing it is $6,000.  You presume that the price of oil in one year to be $100 per barrel. Let's say the discount rate is 10%, how much are you willing to pay for the field? Disregard real option.

Answer 1

1. If ABC company has FCF (free cash flows) of $2,000, $3,000, and $4,000 at the end of years 1, 2, and 3. And the discount rate is 20%. Assuming the present value (PV) of the firm is $9672.50. What is its terminal value? and What is the present value of its terminal value (TV)?

We have following information-

ABC Company has FCF (free cash flows) of $2,000 for year 1

$3,000 for year 2

$4,000 for year 3

Discount rate is 20%

The present value (PV) of the firm is $9672.50

The present value of its terminal value (TV) = the present value (PV) of the firm – Present value of free cash flows for three years

= The present value (PV) of the firm – {free cash flow for year 1/ (1+discount rate) ^1 + free cash flow for year 2/ (1+discount rate) ^2 + free cash flow for year 3/ (1+discount rate) ^3}

= $9672.50 – {$2000/ (1+20%) ^1 + $3000/ (1+20%) ^2 +$4000/ (1+20%) ^3}

= $9672.50 – {$1666.67 + $2083.33 + $2314.82}

= $3,607.69

Therefore the present value of its terminal value (TV) is $3,607.69

2. There are 200 barrels of oil that can be extracted from a field and the price of doing it is $6,000. You presume that the price of oil in one year to be $100 per barrel. Let's say the discount rate is 10%, how much are you willing to pay for the field? Disregard real option.

The price of oil in one year to be $100 per barrel

The discount rate is 10%

Therefore price of oil today = the price of oil in one year / (1+discount rate)

= $100 / (1+10%) = $90.91

Therefore the value of200 barrels of oil that can be extracted from a field = 200 * price of oil today

= 200 *$90.91 = $18,181.82

The price of doing it is $6000

The amount you are willing to pay for the field = the value of200 barrels of oil that can be extracted from a field - the price of doing it

= $18,181.82 -$6000

= $12,181.82

Therefore the amount you are willing to pay for the field is $12,181.82