Question

Sheldon Corporation projects the following free cash flows (FCFs) and interest expenses for the next 3 years, after which FCF and interest expenses are expected to grow at a constant 7% rate. Sheldon’s unlevered cost of equity is 11% its tax rate is 35%. Year 1 2 3 Free cash flow ($ millions) $20 $30 $40 Interest expense ($ millions) $8 $9 $10 What is Sheldon’s unlevered horizon value of operations at Year 3? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places. $ million What is the current unlevered value of operations? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places. $ million What is horizon value of the tax shield at Year 3? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places. $ million What is the current value of the tax shield? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places. $ million What is the current total value of the company? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places. $ million

Answer 1

Growth rate after 3 years			7% or	0.07
Unlevered cost of equity			11% or	0.11
Tax rate				35%
		1	2	3
Free cash flows ($ millions)		20	30	40
Interest exp.($ millions)		8	9	10
(a)
Unlevered horizon value of operations at year 3 = FCF for year 3 * (1+g) / (ke -g)
	40 * (1 + 0.07) / (0.11-0.07)
	1070
So, Unlevered horizon value of operations at year 3 is $1070 millions.
(b)
Current unlevered value of operations is present value of FCF for 3 years and present value of horizon value at year 3
Year	Cash flows	P.V. F. @ 11%	Present value
1	20	0.9009009	$18.02
2	30	0.81162243	$24.35
3	40	0.73119138	$29.25
3	1070	0.73119138	$782.37
			$853.99
So, Current value of operations is $853.99 millions.
(c )
Horizon value of tax shield at 3 Year = Interest expense * (1 + g)* Tax rate / (Ke -g)
	10 * (1+0.07) * 0.35 / (0.11-0.07)
	93.625
So, Horizon value of tax shild is $93.63 millions.
(d )
Current value of tax shield is present value of tax shield for 3 years and present value of horizon value at year 3
Year	Interest exp.	Tax shield@ 35%	P.V. F. @ 11%	Present value
1	8	2.8	0.9009009	$2.52
2	9	3.15	0.81162243	$2.56
3	10	3.5	0.73119138	$2.56
3 (horizon value of tax shield)		93.625	0.73119138	$68.46
				$76.10
So, Current value of the tax shield is $76.10 millions.
(e )
Current total value of company = Current value of operations + Current value of tax shield
	$853.99 + $76.10
	$930.09
So, the current total value of company is $ 930.09 millions.