Question

You are an analyst at a large firm. The Chief Financial Officer presents the following free cash flow data for ABC Corp (in millions of $).
Year Cash Flow
2010 1600
2011 2600
2012 3200
2013 3400
2014 2300
She asks you to please calculate the:
- Geometric Total Return
- The Annualized Rate of Change
Then, the director asks you to make a 10 year cash flow forecast based upon the annualized rate of growth in cash flow.
Next, she asks you to calculate the NPV of the forecasted cash flows assuming an immediate investment cost of $19.8 billion.
To estimate the weighted average cost of capital, please use the following data points.
Market Value of Debt - $580,000,000
Market Value of Equity - $1,302,000,000
Current Yield to Maturity on Debt – 5.1875%
Tax Rate – 35.2%
Expected Return on Market – 11.7%
Current 10 year U.S. Treasury – 4.3%
Beta – 2.41

Answer 1

Cash flows are as follows:

Year	2010	2011	2012	2013	2014
Cash Flow	$1,600	$2,600	$3,200	$3,400	$2,300
% Change		62.5%	23.1%	6.3%	-32.4%

First Part of the question:

Calculation of Geometric total return:-

Geometric total return is the average return each year on an investment that is being compounded over several years. The formula to calculate is as follows:

where,

n= number of periods

r= rate of return

So, using the formula, we can calculate geometric total return on excel:

Geometric total return is the same as Annualized Change.

Second part of the question:

Now, we need to make a 10 year forecast using the Annualized growth rate which we have calculated above. This could be simply done on Excel as follows:

The formulas used are as follows:

Third part of the question:

Calculation of NPV given the following:

From the information given, we need to calculate cost of debt and cost of equity:

Cost of debt will be the current yield to maturity on debt*(1-tax rate). This is because of deduction in taxable income due to debt interest payment.

Therefore, cost of debt= 5.19% * (1-35.20%)= 3.36%

Cost of equity is to be calculated using Capital Asset Pricing Model

CAPM = Risk free rate+ Beta*(Expected Market Return- Risk Free Rate)

= 4.30%+2.41*(11.70%-4.30%)= 22.13%

Now, we can calculate weighted average cost of capital using the following formula:

WACC= cost of debt*(debt/debt+equity) + Cost of equity*(equity/debt+equity)

The calculation is as follows:

The formulas used are as follows:

Now we can calculate NPV of the forecasted cash flows:

The formulas used are as follows: