Question #6531

2. Leak Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).

Year: 1 2

Free cash flow: -$50 $100

a. $1,456

b. $1,529

c. $1,606

d. $1,686

e. $1,770

Year: 1 2

Free cash flow: -$50 $100

a. $1,456

b. $1,529

c. $1,606

d. $1,686

e. $1,770

Expert's answer

Terminal Value in year 2 = CF3/(Ke-g) where

CF3 = cash flow in year 3 = 100X1.05 = 105

Ke = required return = 11%

g = growth rate = 5%

Terminal value in year 2 = 105/(11%-5%) = 1,770

**e. $1,770**

CF3 = cash flow in year 3 = 100X1.05 = 105

Ke = required return = 11%

g = growth rate = 5%

Terminal value in year 2 = 105/(11%-5%) = 1,770

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