Question

Hectoritis Corp. currently has an FCF of $13 million. A reputable analyst estimates that this FCF... Hectoritis Corp. currently has an FCF of $13 million. A reputable analyst estimates that this FCF is anticipated to increase by 12% per year for the next 5 years. The analyst esti- mates that at the end of 5 years the company’s terminal value will be based on the year-5 FCF and a long-term FCF growth rate of 4%. Suppose the Hectoritis ?= 1.5, the rf = 3%, the market risk premium E(rM )–rf = 14%, and Hectoritis has 8 million shares outstanding. Assume all cash flows occur at year end. what is terminal value in year 5?

Answer 1

Step-1:Calculation of Year 5 FCF
Year 5 FCF		=	Current FCF x (1+g)^n			Where,
		=	1,30,00,000	x (1+0.12)^5		Current FCF		1,30,00,000
		=	$ 2,29,10,441.88			g		12%
						n		5
Step-2:Calculation of Required return to be used as discount rate
As per Capital Asset pricing Model,
Required Return		=	Risk free rate+Beta*amrket risk premium
		=	3%	+	1.5	x	14%
		=	24%
Step-3:Calculation of Terminal Value in Year 5
		Terminal Value in Year 5		=	FCF5*(1+g)/(Ke-g)				Where,
				=	22910441.88*(1+0.04)/(0.24-0.04)				FCF5	$ 2,29,10,441.88
				=	$ 11,91,34,297.78				g	4%
									Ke	24%
Thus, Terminal Value in Year 5 is					$ 11,91,34,297.78
or,					$ 119.13	Million