Question

The MoMi Corporation’s cash flow from operations before interest and taxes was $5.6 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 $380,000 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 12% per year, and the firm currently has debt of $7.3 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

Answer:

Value of the firm = $ 43155000

Value of the firm's equity = $ 35855000

Explanation:

The objective of this question is to determine the value of the firm and the value of the firm's equity

Cash flow from operations =( 5.6 million  +  5% of 5.6 million ) = 5880000

Depreciation = ( 380000 + 5% of 380,000 ) = 399000

Taxable income = 5880000 - 399000 = 5481000

Net income (after tax) = ( 5481000 - 35% of 5481000 ) =  3562650

Cash flow from operations (after tax) = 3562650 + 399000 = 3961650 ( which is the depreciation, being non-cash expense)

However, The Free cash flow available =  Cash flow from operations (after tax) - Income from investment

=  3961650 - ( 5600000 × 16%  × 1.05)

=  3961650 -  940800

= 3020850

Value of the firm = Free cash flow available / (Capitalization rate - Growth rate)

Value of the firm = 3020850 / 0.12 - 0. 05

Value of the firm = 3020850 / 0.07

Value of the firm = $ 43155000

Value of the firm's equity = Total value of firm - Value of debt of firm

Value of the firm's equity =  $ 43155000 - $ 7300000

Value of the firm's equity = $ 35855000