Final answer:
To estimate the value of the firm, you would calculate the present value of each of the forecasted cash flows at the discount rate of 10%. The horizon value in this scenario is the cash flow of the last year since the project ends then. The firm value is the sum of all discounted cash flows.
Step-by-step explanation:
To value a company by forecasting a series of cash flows and estimating a horizon value, one might use the formula for the present value of a series of cash flows. For this particular firm with cash flows in years 1 through 4 of $120 million, $130 million, $135 million, and $137 million, respectively, and assuming the project ends at the end of the fourth year, projections are made based on a historical growth rate and a discount rate. The horizon value can be calculated, but in this case since the project ends in year 4, the horizon value is simply the cash flow of the final year.
To calculate the present value of each cash flow, we discount it by the company's discount rate of 10%. The formula for present value (PV) is as follows: PV=Cash Flow/(1+Discount Rate)^n, where 'n' is the number of years in the future the cash flow occurs. Here's how the calculations would look:
- Year 1: $120 million / (1 + 0.10)^1
- Year 2: $130 million / (1 + 0.10)^2
- Year 3: $135 million / (1 + 0.10)^3
- Year 4: $137 million / (1 + 0.10)^4
The value of firm is the sum of these discounted cash flows.