Question

Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?a. $840b. $882c. $926d. $972e. $1,021

Answer 1

Answer:

Option (A) is correct

Explanation:

Given that,

Free cash flow in Year 3, FCF3 = $40 million

FCF to grow at a constant rate, g = 5%

Weighted average cost of capital, WACC = 10%

Cost of equity = 15%

Therefore,

Horizon Value at year, t = 3:

$=\frac{FCF4}{(WACC-g)}$

$=\frac{FCF3(1+g)}{(WACC-g)}$

$=\frac{40(1+0.05)}{(0.10-0.05)}$

$=\frac{42}{0.05}$

     = $ 840