Question

Zhdanov Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million, but its FCF at t = 2 will be $10 million. After Year 2, FCF is expected to grow at a constant rate of 5% forever. If the weighted average cost of capital is 15%, what is the firm’s value of operations, in millions?

Answer 1

Answer:

Ans. The firm’s value of operations, in millions is $82.61 millions

Explanation:

Hi, we need to bring to present value all cash flows, so we need to bring the -10 million to present and the perpetuity value too, the full equation to use is as follows.

$PresentValue=\frac{CF(1)}{(1+WACC)^{1} } +\frac{CF(2)*(1+g)}{(WACC-g)} *\frac{1}{(1+WACC)^{1} }$

Where:

CF(1)= -10

CF(2)=10

WACC=weighted average cost of capital

g= Constant growth rate

It should look like this.

$PresentValue=\frac{-10}{(1+0.15)^{1} } +\frac{10*(1+0.05)}{(0.15-0.05)} *\frac{1}{(1+0.15)^{1} }= 82,61$

the constant growth rate is found by the second part of the equation

$PerpetuityValue=\frac{CF(2)*(1+g)}{(WACC-g)}$

And that brings all the future cash flows to 1 period before its first cash flow, but there is still one period to go in order to take it to present value, so we discounted with.

$\frac{1}{(1+WACC)^{1} }$

so the answer is $82.61 millions.

Best of luck.