Question

The MoMi Corporation’s cash flow from operations before interest, depreciation and taxes was $1.6 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 16% of pretax cash flow each year. The tax rate is 21%. Depreciation was $220,000 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 $2 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:

VALUE OF THE FIRM'S EQUITY

Answer 1

We can calculate the desired results as follows:

Value of Firm = Free Cash Flows for Next period / (WACC - Growth Rate)

Free Cash Flows for Next period

Particulars	Amount
Cash flow from operations before interest and taxes [$1,600,000 x 105%]	$ 1,680,000
Less: Depreciation Expense [$220,000 x 105%]	$ 231,000
Taxable Income	$ 1,449,000
Less: Tax at 21% [$1,449,000 x 21%]	$ 304,290
After-tax unleveraged income	$ 1,144,710
Add Back: Depreciation Expenses	$ 231,000
Net Income after tax	$ 1,375,710
Less: Additional Investment [$1,680,000 x 16%]	$ 268,800
Free Cash Flow for Next period	$ 1,106,910

WACC = 12%

Growth rate = 5%

Value of Firm = 1,106,910 / ( 12% - 5% )

= 1,106,910 / 7%

= $ 15,813,000

b) Value of Equity = Value of Firm - Value of Debt

= 15,813,000 - 2,000,000

= $ 13,813,000

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