The MoMi Corporation’s cash flow from operations before interest and taxes was $

Question

The MoMi Corporation’s cash flow from operations before interest and taxes was $5.6 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 16% of pretax cash flow each year. The tax rate is 35%. Depreciation was $380,000 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 $7.3 million outstanding. Use the free cash flow approach to value the firm’s equity.

Explanation / Answer

Solution: Value the firm’s equity = $35,855,000 Working Notes: Before-tax and interest cash flow from operations 5,880,000 [$5,600,000 x 105%] less: Depreciation 399,000 [$380,000 x 105%] Taxable Income 5,481,000 less: Tax @ 35% 1,918,350 [5,481,000 x 35% ] After-tax unleveraged income 3,562,650 After-tax cash flow from operations 3,961,650 [After-tax unleveraged income + Depreciation ] [3,562,650 + 399,000] Less: New investment [ 16% x cash flow from operations ] 940,800 [5880,000 x 16% ] Free cash flow 3,020,850 The value of the firm (debt + Equity) = Free cash flow /(Capitalization rate - growth rate) = 3,020,850/(0.12- 0.05) =43,155,000 Value the firm’s equity = The value of the firm - Value of debt = 43,155,000 - 7,300,000 =35,855,000 Please feel free to ask if anything about above solution in comment section of the question.

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