Question

River Walk Tours is expected to have an EBIT of $184,000 next year. Depreciation, the increase in net working capital, and capital spending are expected to be $11,000, $1,500, and $13,000, respectively. All are expected to grow at 6 percent per year for three years. After Year 4, the adjusted cash flow from assets is expected to grow at 2.5 percent indefinitely. The company's WACC is 9.2 percent and the tax rate is 21 percent. What is the terminal value of the company’s cash flows?

Answer 1

Answer: $2,584,798.06

Explanation:

We'll calculate the expected free cash flow(FCF) from year 1-5 and this will be:

FCF1 = Expected EBIT × (1 - tax rate) + Expected Depreciation - Expected Increase in net working capital (NWC) - Expected Capital Spending

FCF1 = $184,000 × (1 - 21%) + $11,000 - $1,500 - $13,000

FCF1 = $184,000 × (1 - 0.21) + $11,000 - $1,500 - $13,000 = $141,860

Since the growth rate is 6% for next 3 years and then there'll be a constant growth rate (g) of 2.50% thereafter. Then the expected free cash flow will be:

FCF2 = $141,860.00 × (1 + 6%) = $150,371.60

FCF3 = $150,371.60 × (1 + 6%) = $159,393.90

FCF4 = $159,393.90 × (1 + 6%) = $168,957.53

FCF5 = $168,957.53 × (1 + 2.5%) = $173,181.47

Then we'll calculate the terminal value at the end of Year 4 which will be:

= FCF5 / (WACC - g)

= 173,181.47 / (9.2% - 2.5%)

= 173,181.47 / (0.0920 - 0.0250)

= 173,181.47 / 0.0670

= $2,584,798.06

Therefore, the terminal value of the company’s cash flows is $2,584,798.06