Question

Island Hotels, Inc. (IHI) forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million (negative), but then its FCF will turn positive. At t = 2 IHI’s FCF will be $35 million, and at t = 3 IHI’s FCF will be $59 million. After Year 3, FCF is expected to grow at a constant rate of 5% forever. If IHI’s weighted average cost of capital is 19%, what is the firm's value of operations, in millions? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box

Answer 1

We can calculate the desired result as follows:

Growth Rate after year 3 = 5%

WACC = 19%

Free cash flows for 3rd year = $ 59 Million

Value after 3rd year = Free cash flows for 3rd year * (1 + g) / (WACC – g)

= 59 * (1+5%) / (19%-5%)

= 61.95 / 14%

= $ 442.5 Million

Formulas used in the excel sheet are:

The firm's value of operations comes out to be $ 313.91 Million. So the answer is 313.91

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