Question

Venice Surf Co. expects to generate free cash flows over the next three years of $10 million, $19 million, and $29 million, respectively. After three years the free cash flows are expected to grow indefinitely at an annual rate of 2%. Assuming a weighted average cost of capital of 6%, what would be the terminal or horizon value of the cash flows occurring after the third year? That is, what would be the present value of all free cash flows occurring after the third year as of the end of the third year (beginning of the fourth year)? Present your answer in $ millions rounded to one decimal place, e.g., $234.5.

Answer 1

The terminal or horizon value of the cash flows occurring after the third year is $966.67 million.

To calculate the terminal or horizon value of the cash flows occurring after the third year, we need to find the present value of those cash flows at the end of the third year. We can use the formula for the present value of a perpetuity to do this:

Terminal Value = FCFn / (r - g)

Where FCFn is the free cash flow in the third year ($29 million), r is the weighted average cost of capital (6%), and g is the annual growth rate (2%).

Plugging in the values, we get: Terminal Value = $29 million / (0.06 - 0.02) = $966.67 million.