Question

Suppose you estimate the WACC of the following firm to be 9.5%. You have prepared a 5 year forecast of NOPAT and planned capital expenditures. Beyond the forecast horizon, the firm plans to pay out 85% of its NOPAT and believes it can maintain the ROIC realized in the final year of the forecast indefinitely. If the firm in question currently has $37.5 million in Invested Capital, what is your estimate of the current Market Value of the firm?

Values in Millions

YEAR	0	1	2	3	4	5
NOPAT		5.63	5.01	5.07	5.12	5.02
REINVESTMENT RATE		100%	75%	60%	40%	20%

Answer 1

Please see the table below. All financials are in $ million. Please see the second row / column to understand the mathematics.

YEAR	Linkage	0	1	2	3	4	5
NOPAT	A		5.63	5.01	5.07	5.12	5.02
REINVESTMENT RATE	B		100%	75%	60%	40%	20%
Reinvestment	C = A x B		5.63	3.7575	3.042	2.048	1.004
Invested capital	Dn = Dn-1 + Cn	37.5	43.13	46.89	49.93	51.98	52.98
Free cash flows	A - C		-	1.25	2.03	3.07	4.02

ROIC realized in final year, ROIC = NOPAT of year 5 / Invested capital in year 5 = 5.02 / 52.98 = 9.48%

Reinvestment rate in year 6, RR = 1 - payout rate = 1 - 85% = 15%

Hence, terminal growth rate, g = ROIC x RR = 9.48% x 15% = 1.42%

Hence, the free cash flow in year 6 = C6 = NOPAT in year 5 x (1 + g) x (1 - RR) = 5.02 x (1 + 1.42%) x (1 - 15%) = 4.33

Hence the terminal value of cash flows at the end of year 5 = C6 / (r - g) = 4.33 / (9.5% - 1.42%) = 53.57

Hence, the current Market Value of the firm = PV of all the future cash flows + PV of terminal value

=  0 + 1.25 / (1 + 9.5%)² + 2.03 / (1 + 9.5%)³ + 3.07 / (1 + 9.5%)⁴ + 4.02 / (1 + 9.5%)⁵​​​​​​​ + 53.57 x (1 + 9.5%)^-5 = 41.31 = $ 41.31 million