Question

Allison's is expected to have annual free cash flow of $62,000, $65,400, and $68,900 for the next three years, respectively. After that, the free cash flow is expected to increase at a constant rate of 2 percent per year. At a discount rate of 14.5 percent, what is the present value of this firm?

Answer 1

Answer:

Present value of the firm = $ 524,467.50

Explanation:

Using the free cash flow, the value of a firm is the the present value of the free cash discounted at the appropriate cost of capital.

Year                                                         PV

1      62,000× (1.145)^(-1)  =               54,148.47162

2    65,400 × (1.145)^(-2)   =             49,884.63225

3      68,900 ×  (1,145)^(-3)  =            45, 898.95119

4 to infinity ( see working below)    $374,535.44

Workings

Present value from Year 4 to infinity (this will be done in two steps)

Step 1

PV in year 3 =  FCF × (1+g)/(WACC- g)

                      FCF -68,900, g =2%, WACC - 14.5%

                       = ( 68,900 × 1.02(/0.145-0.02)

                    =  $562,224.00

Step 2

PV in year 0 = PV in year 3 × (1+r)^(-3)

                   = $562,224.00 × (1.145^(-3)

                    = $374,535.44

The present value of Allison =

 54,148.47 + 49,884.63 +45,898.95  +374,535.44

= $ 524,467.50

Present value of the firm = $ 524,467.50