Bay Properties is considering starting a commercial real estate division. It has

Question

Bay Properties is considering starting a commercial real estate division. It has prepared the following four-year forecast of free cash flows for this division:

$199,000

Assume cash flows after year 4 will grow at 2% per year, forever. If the cost of capital for this division is 10%, what is the continuation value in year 4 for cash flows after year 4? What is the value today of this division?

What is the continuation value in year 4 for cash flows after year 4?

The continuation value is $ (? ).

What is the value today of this division?

The value today is $ ( ? ).

Year 1 Year2 Year 3 Year 4 Free cash flow -$181,000 $14,000 $97,000

$199,000

Explanation / Answer

Compute the continuation value.

Continuation value = Cash flow at year 4 / 0.10 - 0.02 = $199,000/0.08 = $2,487,500.

Compute the value today.

Year Cash Flow Discount @10% Present value of cash flows 1 1        (181,000.00)            0.91        (164,545.45) 2            14,000.00            0.83            11,570.25 3            97,000.00            0.75            72,877.54 4          190,000.00            0.68          129,772.56 4      2,487,500.00            0.68      1,698,995.97 Present Value of Cash Flows      1,748,670.86

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