Answer to Question #13225 in Management for John

Question

Vasudevan Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 13% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the Year 0 value of operations, in millions?
Year: 1 2 3
Free cash flow: -$20 $42 $45
a. $586
b. $617
c. $648
d. $680
e. $714

Answer 1

The answer is: b ($617)


Explanation:
The growth rate g=$45/$42-1.0=7,14%
Terminal value at Year 2 = free cash flow/(WACC-g)=45/(0.13 - 0,0714)=$768

Value of operations = -$20(1.13) ($42+$768)/(1.13)2 = $ 617