Question

Tomkat Corp. has only a single asset.  This asset generates operating cash flow of $200,000 per year, in perpetuity.   Tomkat also has a single liability, which is a perpetual bond (the maturity date is infinitely far in the future) that has a face value of $1 million and that pays coupon interest at a rate of 8% once per year.   The appropriate discount rate for all cash flows in this problem is 10% per year. (a) What is the value of Tomkat’s equity? Assume now, that in addition to the asset and liability described above, Tomkat is working on a new project.   The project requires an immediate investment of $400,000, and will require another investment of $600,000 a year from now.  Two years from now the project will generate a positive operating cash flow of $60,000, and subsequent operating cash flows will grow by 5% per year in perpetuity.  Continue to assume a discount rate of 10% per year. (b) What is the value of Tomkat’s equity given the existence of this “growth opportunity”?

Answer 1

A	B	C	D	E
2
3
4
5		Operating cash flow	200000
6		Interest	80000
7		Free cash flow to equity	120000
8		Discount rate	10%
9	a)	Value of equity	1200000
10
11	b)
12		Growth	5%
13		Discount rate	10%
14		Operating cash flow	60000
15		PV of operating cash flow	1090909.091
16		NPV	145454.5455
17
18		Value of equity	1345454.55
19
20

A	B	C	D	E
2
3
4
5		Operating cash flow	200000
6		Interest	=1000000*8%
7		Free cash flow to equity	=D5-D6
8		Discount rate	0.1
9	a)	Value of equity	=D7/D8
10
11	b)
12		Growth	0.05
13		Discount rate	0.1
14		Operating cash flow	60000
15		PV of operating cash flow	=D14/((D13-D12)*(1+10%))
16		NPV	=D15-600000/1.1-400000
17
18		Value of equity	=D9+D16
19
20