Question

Problem 18-19 The MoMi Corporation's cash flow from operations before interest and taxes was $3 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 15 % of pretax cash flow each year. The tax rate is 35 %. Depreciation was $250,000 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 8 % per year, and the firm currently has debt of $4.5 million outstanding. Use the free cash flow approach to value the firm's equity (Round answer to nearest whole number. Enter your answer in dollars not in millions.) 10 points Skipped eBook Value of the equity Prist References

Answer 1

Cash flow from Operations before interest and tax =Previous year Cash flow from Operations before interest and tax + 5% growth on Previous year Cash flow from Operations before interest and tax
= $3,000,000 + ($3,000,000 * 5%)
= $3,150,000

Depreciation = $250,000 + ($250,000 * 5%) = $262,500.

Taxable income = $3,150,000 - $262,500 = $2,887,500

After Tax unleveraged income = $2,887,500 * (1 - 35%) = $1,876,875.

After Tax Cash flow from Operation = $1,876,875 + $262,500 = $2,139,375

New Investment @15% of Cash Flow from operation = $3,150,000 * 15% = $472,500.

Free cash flow = $2,139,375 - $472,500 = $1,666,875

Present value of all future free cash flow = $1,666,875 / (8% - 5%)
= $55,562,500

Value of equity = $55,562,500 - $4,500,000 = $51,062,500.