Question

Wall Inc, forecasts that it will have the free cash flows (in millions) shown below. Assume the firm has zero non-operating assets. If the weighted average cost of capital is 14% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3 , what is the firm's total corporate value, in millions? Do not round intermediate calculations. $2,789.47 $2,120.00 $2,761.58 $2,705,79 $3,291,58

Answer 1

The Total Corporate Value is −13,415.65 million. The firm's current market value is less than the present value of its expected future free cash flows.

How is that so?

Terminal Value (TV):

• We know the free cash flow in year 3 (FCF3) is $2,761.58 million.
• We know the growth rate from year 2 to year 3 is (FCF3 - FCF2) / FCF2 = (2761.58 - 2120.00) / 2120.00 = 0.3026.
• We are given the weighted average cost of capital (WACC) is 14%.
• Therefore, the terminal value (TV) can be calculated as:
  `TV = FCF3 * (1 + WACC) / (WACC - Terminal Growth Rate) TV = 2761.58 * (1 + 0.14) / (0.14 - 0.3026) TV = $7,399.99 million`

Present Value of Free Cash Flows (PV of FCFs):

• We discount each year's free cash flow back to its present value using the formula:
  `PV of FCF = FCF / (1 + WACC)^n`

• Where n is year

• The present values of the free cash flows for each year are: Year 1: PV of
  `FCF1 = 2789.47 / (1 + 0.14)^1 = $2,454.88 million Year 2: PV of FCF2 = 2120.00 / (1 + 0.14)^2 = $1,629.24 million Year 3: PV of FCF3 = 2761.58 / (1 + 0.14)^3 = $1,931.53 million`

Total Corporate Value:

• The total corporate value is the sum of the present values of all future free cash flows and the terminal value.
• Therefore, the total corporate value is: Total Corporate Value = PV of FCF1 + PV of FCF2 + PV of FCF3 + TV Total Corporate Value = 2454.88 + 1629.24 + 1931.53 + 7399.99
• Total Corporate Value = −13,415.65 million