XYZ Inc has never paid a dividend. Free cash flow is projected to be $80,000 and

Question

XYZ Inc has never paid a dividend. Free cash flow is projected to be $80,000 and $100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 9%. The company's weighted average cost of capital is 15%.

A) What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.) Round your answer to the nearest cent.

B) Calculate the value of XYZ's operations. Round your answer to the nearest cent. Round intermediate calculations to two decimal places.

Explanation / Answer

(‘A)

Terminal Value = CF3/ (Ke – G)

Where CF3 =Cash Flow at end of year 3

CF3 = CF2   x (1.09)

CF3 = $ 100,000 x (1.09)

CF3= $ 109,000

Ke = WACC = 15 %

G= Growth rate= 9 %

Terminal Value= 109,000/ ( 0.15-0.09)

Terminal Value= $ 18,16,666.67

(B)- Value of Operation of XYZ

Value= CF1 / (1+r)1 + CF2/ (1+r)2 + TV/ (1+r)2

Value= $80000/1.15 + 100,000/( 1.15)2 + 1816666.67 / (1.15)2

Value= $1,518,840.58

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