Question

The MoMi Corporation’s cash flow from operations before interest and taxes was $4 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 16% of pretax cash flow each year. The tax rate is 35%. Depreciation was $300,000 in the year just ended and is expected to grow at the same rate as the operating cash flow. The appropriate market capitalization rate for the unleveraged cash flow is 13% per year, and the firm currently has debt of $6.5 million outstanding. Use the free cash flow approach to value the firm’s equity. (Round answer to nearest whole number. Enter your answer in dollars not in millions.)

Answer 1

Value of Firms Equity using free cash flow approach

Particulars	Amount ($)
Cash flow from operations before interest and taxes [$40,00,000 x 105%]	$42,00,000
Less: Depreciation Expenses [$300,000 x 105%]	315,000
Taxable Income	38,85,000
Less: Tax at 35% [$38,85,000 x 35%]	13,59,750
After-tax unleveraged income	25,25,250
Add Back: Depreciation Expenses	315,000
Net Income after tax	28,40,250
Less: Additional Investment [$42,00,000 x 16%]	672,000
Free Cash Flow (FCF)	21,68,250

Total Value of the firm

Total Value of the firm = Free cash flow / (market capitalization rate – Growth Rate)

= FCF / (Ke – g)

= $21,68,250 / (0.13 – 0.08)

= $21,68,250 / 0.08

= $2,71,03,125

Value the firm’s Equity

Value the firm’s Equity = Total Value of the firm – Market Value of Debt

= $2,71,03,125 - $65,00,000

= $2,06,03,125

“Hence, the value the firm’s equity would be $2,06,03,125”