Question #13222

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

The answer is: e ($ 1,770)

Explanation:

Terminal alue 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

Explanation:

Terminal alue 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

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