Question

?Acquirer Company’s management believes that there is a 70 percent chance that Target Company’s free cash flow to the firm will grow at 25 percent per year during the next five years from this year’s level of $4 million. Sustainable growth beyond the fifth year is estimated at 5 percent per year. However, they also believe that there is a 30 percent chance that cash flow will grow at half that annual rate during the next five years and then at a 3.5 percent rate thereafter. The discount rate is estimated to be 14 percent during the high growth period and 11 percent during the sustainable growth period for each scenario. What is the expected value of Target Company?

This is my answer and I believe its incorrect please check it and provide the correct answer

• 70% Chance Value=4*1.25/1.11+4*(1.25/1.11)^2+4*(1.25/1.11)^3+4*(1.25/1.11)^4+4*(1.25/1.11)^5+4*(1.25/1.11)^5*(1.05/(11%-5%))=155.7416568

• 30% Chance Value=4*1.125/1.11+4*(1.125/1.11)^2+4*(1.125/1.11)^3+4*(1.125/1.11)^4+4*(1.125/1.11)^5+4*(1.125/1.11)^5*(1.035/(11%-3.5%))=79.85747356

Expected value=70%*155.7416568+30%*79.85747356=132.9764018

Answer 1

Value of Firm in High Growth period that is 70% probability is calculated in excel and screen shot provided below:

Value of Firm in High Growth period that is 70% probability is $100.56 million.

Value of Firm in Low Growth period that is 30% probability is calculated in excel and screen shot provided below:

Value of Firm in Low Growth period that is 30% probability is $79.86 million.

Expected value of firm = (70% × $100.56) + (30% × $79.86)

= $70.392 + $23.958

= $94.35 million.

Expected value of firm is $94.35 million.