Question

The MoMi Corporation’s cash flow from operations before interest and taxes was $3.2 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 20% of pretax cash flow each year. The tax rate is 21%. Depreciation was $380,000 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.)

Answer 1

Solution:
	Value of the firm	$29,517,000
	Value of the firm's equity	$24,517,000
Working Notes:
Notes:	First of all we calculate Free cash flow which we get '= Earnings After taxes + Depreciation - Investment
	Then free cash flow will be used to get value of the firm Gordon method with constant growth rate. And at last value of equity by reducing value of debt from value of the firm.
	Computation of value of the firm
	Earnings before interest, taxes & depreciation		$3,360,000	A
	[$3,200,000 x (1.05)]
Less:	Depreciation		$399,000	B
	[$380,000 x (1.05)]
	Taxable Income		$2,961,000	C=A-B
Less:	Taxes @ 21%		$621,810	D
	[$2,961,000 x 21% ]
	Earnings( unleveraged) After-tax		$2,339,190	E=C-D
	After-tax cash flow from operations		$2,738,190	F=E + B
	[Earnings( unleveraged) After-tax + Depreciation ]
	[$2,339,190 +$399,000]
Now
	New investment (20% of cash flow from operations the EBIT)		$672,000	G= A x 15%
	[20% x $3,360,000]
	Free Cash Flow		$2,066,190	H=F- G
	[After-tax cash flow from operations - New investment]
	[$2,738,190- $672,000]
	Firm value = Free cash flow/(Unlevered capitalization rate - growth rate)
	=$2,066,190/(0.12 - 0.05)
	=$29,517,000
	Value of the firm's equity = Value of firm - Value of debt outstanding
	=$29,517,000 - $5,000,000
	=$24,517,000
Please feel free to ask if anything about above solution in comment section of the question.