Question

1. Rayco Corporation’s free cash flow in 2019 is $24 million. This is expected to grow by 6% for the next three years. Thereafter, it grows by 2% each year forever. The market value of debt outstanding is $17 million, and weighted average cost of capital is 15%.

1. Determine the terminal value of the firm.
2. What model would you use to value the firm?
3. Determine the value of the firm, and the value of equity.

Answer 1

  

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FCF 0 = 24

FCF 1 = 24 * (1+0.06) = 25.44 mn

FCF 2 = 25.44 * (1+0.06) = 26.9664 mn

FCF 3 = 26.9664 * (1+0.06) = 28.584384 mn

FCF 4 = 28.584384 * (1+0.02) = 29.15607168 mn

Answer A)

Terminal Value = FCF 4 / WACC - G

= 29.15607168 mn / 0.15 - 0.02

= 224.277474461 mn

Answer B)

Discounted Cash flow method should be used.

Answer C)

Value of Firm = Value of 3 years Cash Flows + PV of Terminal Value

= FCF 1 / (1+r)^1 + FCF 2 / (1+r)^2 + FCF 3 / (1+r)^3 + Terminal Value / (1+r)^3

= 25.44 / (1+0.15)^1 + 26.9664 / (1+0.15)^2 + 28.584384 / (1+0.15)^3 + 224.277474461 / (1+0.15)^3

= 208.77 mn

Value of Equity = Value of Firm - Value of Debt

= 208.77 mn - 17 mn

= 191.77 mn

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