Question

Allison's is expected to have annual free cash flow of $62,000, $65,400, and $68,900 for the next three years, respectively. After that, the free cash flow is expected to increase at a constant rate of 2 percent per year. At a discount rate of 14.5 percent, what is the present value of this firm?

Answer 1

Present value of the firm = $ 524,467.50

Step-by-step explanation:

Using the free cash flow, the value of a firm is the the present value of the free cash discounted at the appropriate cost of capital.

Year PV

1 62,000× (1.145)^(-1) = 54,148.47162

2 65,400 × (1.145)^(-2) = 49,884.63225

3 68,900 × (1,145)^(-3) = 45, 898.95119

4 to infinity ( see working below) $374,535.44

Workings

Present value from Year 4 to infinity (this will be done in two steps)

Step 1

PV in year 3 = FCF × (1+g)/(WACC- g)

FCF -68,900, g =2%, WACC - 14.5%

= ( 68,900 × 1.02(/0.145-0.02)

= $562,224.00

Step 2

PV in year 0 = PV in year 3 × (1+r)^(-3)

= $562,224.00 × (1.145^(-3)

= $374,535.44

The present value of Allison =

54,148.47 + 49,884.63 +45,898.95 +374,535.44

= $ 524,467.50

Present value of the firm = $ 524,467.50