In: Finance
The MoMi Corporation’s cash flow from operations before interest
and taxes was $2.5 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 19% of pretax cash
flow each year. The tax rate is 21%. Depreciation was $310,000 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.
(Enter your answer in dollars not in
millions.)
Value of the firm |
$23,476,500 |
Value of the firm's equity |
$18,476,500 |
Value of Firms Equity using free cash flow approach
Particulars |
Amount ($) |
Cash flow from operations before interest and taxes [$2,500,000 x 105%] |
2,625,000 |
Less: Depreciation Expenses [$310,000 x 105%] |
325,500 |
Taxable Income |
2,299,500 |
Less: Tax at 21% [$2,299,500 x 21%] |
482,895 |
After-tax unleveraged income |
1,816,605 |
Add Back: Depreciation Expenses |
325,500 |
Net Income after tax |
2,142,105 |
Less: Additional Investment [$2,625,000 x 19%] |
498,750 |
Free Cash Flow (FCF) |
1,643,355 |
Total Value of the firm
Free Cash Flow (FCF) = $1,643,355
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)
= $1,643,355 / (0.12 – 0.05)
= $1,643,355 / 0.07
= $23,476,500
Value the firm’s Equity
Value the firm’s Equity = Total Value of the firm – Market Value of Debt
= $23,476,500 - $5,000,000
= $18,476,500