Question

Kinkead Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm's value of operations, in millions?

Select one:
a. $158
b. $167
c. $175
d. $184
e. $193

Answer 1

correct option is b. $167

Step-by-step explanation:

given data

free cash flow FCF 1 = -$10 million

t = 1

free cash flow FCF 2= $20 million

t = 2

FCF grow rate = 4%

average cost of capital = 14%

to find out

what is the firm's value of operations

solution

first we get here firm value in year 2 that is express as

firm value in year 2 = expected FCF in 3 ÷ (cost of capital - growth) .........1

put here value

firm value in year 2 =
`(20*(1+0.04))/(0.14 - 0.04)`

firm value in year 2 = 208 million

and

firm value of operation this year will be as

firm value = discounted value in year 2 + discounted FCF1 and FCF2 .............2

firm value =
`(208)/((1+0.14)^2) +(20)/((1+0.14)^2) +(-10)/((1+0.14))`

firm value = 166.67 = 167 million

so correct option is b. $167