Question

The MoMi Corporation’s cash flow from operations before interest and taxes was \(2 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 20% of pretax cash flow each year. The tax rate is 35%. Depreciation was \)200,000 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 $4 million outstanding. Use the free cash flow approach to value the firm’s equity.

Short answer

$10, 550, 000

Step-by-step solution

Step by Step SolutionStep 1: Given information

r_f= 8% or 0.08

E(r_M) = 15% or 0.15

β= 1.2

ROE = 20% = 0.20

g = b x ROE = 0.6 x 0.20 = 0.12 = 12%

k = r_f+β[E(r_m) - r_f[

= 0.08 + 1.2 x (0.15 – 0.08)

= 0.164 or 16.4%

Calculation of the value of the firm (i.e. debt + equity)

V₀= FCFF₁ / k – g

= $1,018,500 / 0.12 – 0.5

= $14,550,000

Calculation of the value of the equity (i.e. Value of firm - debt)

Thus value of equity = Value of the firm - value of the debt

= $14550000 - $4000000

= $10, 550, 000