Consider a firm as follows: Assume that the firm has no debt. The cashflows are received...

Consider a firm as follows: Assume that the firm has no debt. The cashflows are received at the end of each year and are perpetual. Cost of equity capital for an unlevered firm, r0, is 20%. The first cash-flow will be received one year from today. All calculations for valuation are done today. Firm value is defined as collective value of debt and equity.

Sales = $ 500,000

Cash Costs = 360,000

Operating Income = 140,000

Tax @ 34% -47,600

Unlevered cash flow (UCF) $ 92,400

Find the firm value, using

a) APV method $__________.

b) FTE method $__________.

c) WACC method $__________.

Expert Solution

a) The adjusted present value is the net present value (NPV) of a project or company if financed solely by equity plus the present value (PV) of any financing benefits, which are the additional effects of debt.
Since there is no debt, APV = NPV of cash flows
As Cash Flows are perpetual, Value of firm using APV = CF/r0 = 92400/0.2 = $462,000

b) Flow to Equity Method (FTE) is a valuation method that calculates the free cash flow available to equity holders, FCFE, taking into account all payments to and from debt holders, the cash flows to equity holders are then discounted using the equity cost of capital r_e
Since there is no debt and there are perpetual cash flows, Value of firm using FTE = CF/r0 = 92400/0.2 = $462,000

c) Weighted Average Cost of Capital ( WACC) method calculates the value of firm by discounting Free Cash Flow to firm by wacc.
Since there is no debt, wacc is same as cost of equity
Therefore with perpetual cash flows, value of firm using Wacc = CF/r0 = 92400/0.2 = $462,000

jeff jeffy answered 1 year ago

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