Question

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.)

Answer 1

Value of Firms Equity using free cash flow approach

Particulars	Amount ($)
Cash flow from operations before interest and taxes [$3,000,000 x 105%]	3,150,000
Less: Depreciation Expenses [$250,000 x 105%]	262,500
Taxable Income	2,887,500
Less: Tax at 35% [$2,887,500 x 35%]	1,010,625
After-tax unleveraged income	1,876,875
Add Back: Depreciation Expenses	262,500
Net Income after tax	2,139,375
Less: Additional Investment [$3,150,000 x 15%]	472,500
Free Cash Flow (FCF)	1,666,875

Total Value of the firm

Free Cash Flow (FCF) = $1,666,875

Growth Rate per year (g) = 5.00% per year

Required Rate of Return (Ke) = 8.00% per year

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

= FCF / (Ke – g)

= $1,666,875 / (0.08 – 0.05)

= $1,666,875 / 0.03

= $55,562,500

Value the firm’s Equity

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

= $55,562,500 - $4,500,000

= $51,062,500