Question

Problem 18-19

The MoMi Corporation’s cash flow from operations before interest and taxes was $3 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 35%. Depreciation was $250,000 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 8% per year, and the firm currently has debt of $4.5 million outstanding. Use the free cash flow approach to value the firm’s equity. (Round answer to nearest whole number. Enter your answer in dollars not in millions.)

value of equity

Answer 1

	Given that
	We can compute value of equity by computing value of firm less value of debt. DDM model can be used to compute value of firm
	However, first we need to compute free cash flow for the firm
			Current	Growth rate	Expected
i	Cash flow before tax and interest from operation		$       3,000,000	5%	$         3,150,000
ii	Depreciation		$          250,000	5%	$            262,500
iii=i-ii	Taxable income		$       2,750,000		$         2,887,500
iv=iii*35%	Tax @ 35%		$          962,500		$         1,010,625
v=iii-iv	After Tax cash income		$       1,787,500		$         1,876,875
vi=v+ii	After tax cash flow from operation		$       2,037,500		$         2,139,375
vii=i*15%	Investment from free cash flow @ 15%				$            472,500
viii=vi-vii	Net free cash flow after investment				$         1,666,875
ix	Value of the firm = Expected annual cash flow/(required rate - growth)=viii/(8%-5%				$       55,562,500
x	Value of debt				$         4,500,000
xi	Value of equity =ix-x				$       51,062,500