You are valuing a private company. Its just generated a cash flow of $5,000. You

Question

You are valuing a private company. Its just generated a cash flow of $5,000. You predict that the company’s annual cash flow growth rate will be 30% over next 3 years. From the fourth year to the fifth year, the annual cash flow growth rate will slow down to 10%. Then from the sixth year and onward, the sustainable long-run annual growth rate will settle to 1%. Due to policy incentives, the company’s cost of capital will be 5% (per year) for the next five years. From the sixth year, its cost of capital will be 10% (per year).please draw a cash flow line

(a) Calculate the cash flow at the end of the sixth year.

(b) Use the number you get from (a) to calculate the value of this company’s future cash flows at the end of the fifth year. (Do not include the fifth year cash flow in this valuation.)

(c) What is the value of the company today?

Explanation / Answer

1.
Cash flow at the end of year 1=5000*1.3=6500
Cash flow at the end of year 2=6500*1.3=8450
Cash flow at the end of year 3=8450*1.3=10985
Cash flow at the end of year 4=10985*1.1=12083.5
Cash flow at the end of year 5=12083.5*1.1=13291.85
Cash flow at the end of year 6=13291.85*1.01=13424.7685

2.
=Cash flow at the end of year 6/(cost of capital-growth rate)=
=13424.7685/(10%-1%)=149164.0944

3.
Value of the company today=6500/1.05+8450/1.05^2+10985/1.05^3+12083.5/1.05^4+13291.85/1.05^5+149164.0944/1.05^5=160573.74

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