The momi corporation’s cash flow from operations before interest and taxes was $1.9 million in the year just ended, and it expects that this will grow by 5% per year forever. to make this happen, the firm will have to invest an amount equal to 19% of pretax cash flow each year. the tax rate is 21%. depreciation was $250,000 in the year just ended and is expected to grow at the same rate as the operating cash flow. the appropriate market capitalization rate for the unleveraged cash flow is 12% per year, and the firm currently has debt of $5 million outstanding. use the free cash flow approach to calculate the value of the firm and the firm’s equity. (enter your answer in dollars not in millions.)

firm value 20,850,000

equity value 15,850,000

Explanation:

firm value = Fre Cash Flow Firm discounted at the WACC

Similar to the gordon model but using the Free Cash Flow of the Firm instead of dividends:

WACC = 12%

growth = 5%

FFCF1 would be the next Free Cash Flow of the Firm

EBIT - Income Tax + Depreciation - Working Capital Investment = Free Cash Flow Firm

Working Capital Investment: 19% of ebit

1,900,000 x 19% = 361,000

Depreciation 250,000

income tax 21% of ebit = 399,000

1,900,000 - 361,000 - 399,000 + 250,000 = 1,390,000 Current Year

FFCF x (1+g) = FFCF1 = 1,390,000 x 1.05 = 1,459,500

Now we calculate the firm value

1,459,500/(0.12-0.05) = 20,850,000

If the firm has 5,000,000 debt then their equity is:

equity value = firm value – market value of debt

20,850,000 - 5,000,000 = 15,850,000

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