Question

Gonzales Corporation generated free cash flow of $88 million this year. For the next two years,the companyʹs free cash flow is expected to grow at a rate of 10%. After that time, the companyʹsfree cash flow is expected to level off to the industry long-term growth rate of 4% per year. Ifthe weighted average cost of capital is 12% and Gonzales Corporation has cash of $100 million,debt of $300 million, and 100 million shares outstanding, what is Gonzales Corporationʹsexpected terminal enterprise value in year 2?A) $1384.24B) $1245.82C) $1107.39D) $968.97

Answer 1

option (A) $1,384.24

Step-by-step explanation:

Given:

Free Cash Flow in Year 3 = $88 million

Expected growth rate = 10% = 0.1

Constant Growth Rate, gC = 4%

Gonzales Corporationʹsexpected terminal enterprise value in Year 2

=
`\frac{\textup{FCF3}}{\textup{(WACC - gC)}}`

=
`\frac{FCF0*(1+gH)^2*(1+gC)}{\textup{(WACC - gC)}}`

Here,

FCF3 is the Free Cash Flow in Year 3

FCF3 is Free Cash Flow Now

=
`\frac{\textup{88*(1 + 0.10)^2*(1 + 0.04)}}{\textup{(0.12 - 0.04)}}`

= $1,384.24

Hence,

The correct answer is option (A) $1,384.24