Answer:
Kindly check explanation
Explanation:
Given the following :
Previous year cash flow from operations before interest, depreciation and taxes = $2.0 million
Growth rate (g) = 5% per year
Pretax cashflow per year = 20%
Tax rate = 21%
Depreciation = $260,000
Market capitalization rate = 10%
Outstanding debt = 4 million
Cash flow from operation before interest tax:
Previous year cashflow + (5% growth in previous year)
(2,000,000) + (0.05 * 2,000,000)
(2,000,000 + 100,000) = $2,100,000
Depreciation + growth (5%):
260,000 + (260,000*0.05) = $273,000
Taxable income = cashflow - depreciation
Taxable income = $(2,100,000 - 273,000)
= $1,827,000
Tax amount = 0.21 * 1827000 = $383670
After tax income = (1827000 - 383670):
After tax income = $1,443,330
After tax cash flow from operations :
(After tax unleveraged income + Depreciation)
After tax Cash flow from Operation = $1,443,330 + $273,000 = $1716330
New investment :
20% of pretax cashflow from operation:
0.2 * $2,100,000 = $420,000
Free cash flow = $1716330 - $420,000 = $1,296,330
Present value of all future free cash flow:
Free cashflow / (capitalization rate - growth rate) = 1296330 / (0.1 - 0.05)
= 1296330 / 0.05
= $25,926,600
Hence, value of firm = $25,926,600
Value of equity :
Value of firm - outstanding debt
$25,926,600 - $4,000,000
= $21,926,600
