Question

In: Finance

When DFC is used on their valuation, company ABC for the current year pretax operating income...

When DFC is used on their valuation, company ABC for the current year pretax operating income of $750,000. Income has grown 2% annually during the last five years, and is expected to continue growing at that rate for the next two years. Net operating working capital increased by $60,000 during the current year and current year capital spending on long-lived assets exceeded depreciation by $75,000. Both working capital and the excess of capital spending over depreciation are projected to grow at the same rate as operating income. Subsequent to the second year, you believe the pretax operating income growth rate will increase to 3% per year and remain at that level into the foreseeable future. The 10-year Treasury bond rate is 2.5%, the equity risk premium is 5.5%, and the marginal federal, state, and local tax rate is 35%. ABC's beta and its target debt-to-equity ratio are 1.74 and 0.67, respectively. Its pretax cost of borrowing, based on its recent borrowing activities, is 9%. please calculate the enterprise value

Expert Solution

Cost of equity = Risk Free rate + (Market Risk Premium × Beta)

= 2.50% + (5.50% × 1.74)

= 2.50% + 9.57%

= 12.07%

COst of equity is 12.07%.

Debt equity ratio = 0.67

Weight of debt = 0.67 / (1 + 0.67)

= 40%

Weight of equity = 60%

Target capital structure weight of debt is 40% and weight of equity is 60%.

WACC is calculated below:

WACC = (60% × 12.07%) + (40% × 9%) × (1 - 35%)

= 7.24% + 2.34%

= 9.58%

WACC that is cost of capital of company is 9.58%.

Free Cash flow = NOPAT - Change in working capital - Capex

= $750,000 × (1 - 35%) - $60,000 - $75,000

= $487,500 - $135,000

= $352,500.

free cash flow of firm in current year is $352,500. Free cash flow will grow at 2% for next 2 year and after that grow at 3% forever.

So,using DCF method, value of firm is calculated in excel and screen shot providedbelow:

Value of firm is $5,412,776.

jeff jeffy answered 2 years ago

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