Question

universitet . A firm is expected to generate the following free cash flows over the next five years: Year FCF In millions 53.2 67.5 78.974.6 80.3 . After that, the free cash flows are expected to grow at the industry average of 4.3% per year. Using the DCF model and a weighted average cost of capital of 13.6%, what is the enterprise value of the firm? 53.2 67.5 78.9 74.6 80.3 1.136 1.13636.136 0.136-0.043 1.136 = 716.22

hi guys can someone please explain this to me, lookating at the last cash flow which is in year 5, why is it discoubted to year 4?

Answer 1

Ideally, the terminal value should have been calculated using a 6th year cash flow. The 6th years cash flow shall be $80.30*(1+0.043) which is the perpetual growth rate.

The cash flows should have been as such:

Year	Cash Flow	Terminal value	Total	DF	PV
1	$    53.20		$    53.20	0.880282	$    46.83
2	$    67.50		$    67.50	0.774896	$    52.31
3	$    78.90		$    78.90	0.682127	$    53.82
4	$    74.60		$    74.60	0.600464	$    44.79
5	$    80.30	$              900.57	$ 980.87	0.528577	$ 518.46
6	$    83.75
				Total	$ 716.22

The last cash flow that you are seeing in the image is the terminal value that is being discounted. The formula for terminal value used a cash flow of next year. That's why, it is calculated a year back. Therefore it is calculated back to year 4.

Using the calculation from image, the answer is also $716.22

Year	Cash Flow	Terminal value	Total	DF	PV
1	$    53.20		$    53.20	0.880282	$                                      46.83
2	$    67.50		$    67.50	0.774896	$                                      52.31
3	$    78.90		$    78.90	0.682127	$                                      53.82
4	$    74.60	863.4409	$ 938.04	0.600464	$                                   563.26
5	$    80.30
				Total	$                                   716.22