Hectoritis Corp. currently has an FCF of $13 million. A reputable analyst estima

Question

Hectoritis Corp. currently has an FCF of $13 million. A reputable analyst estimates that this FCF... Hectoritis Corp. currently has an FCF of $13 million. A reputable analyst estimates that this FCF is anticipated to increase by 12% per year for the next 5 years. The analyst esti- mates that at the end of 5 years the company’s terminal value will be based on the year-5 FCF and a long-term FCF growth rate of 4%. Suppose the Hectoritis ?= 1.5, the rf = 3%, the market risk premium E(rM )–rf = 14%, and Hectoritis has 8 million shares outstanding. Assume all cash flows occur at year end. what is terminal value in year 5?

Explanation / Answer

Step-1:Calculation of Year 5 FCF Year 5 FCF = Current FCF x (1+g)^n Where, =            1,30,00,000 x (1+0.12)^5 Current FCF         1,30,00,000 = $ 2,29,10,441.88 g 12% n 5 Step-2:Calculation of Required return to be used as discount rate As per Capital Asset pricing Model, Required Return = Risk free rate+Beta*amrket risk premium = 3% + 1.5 x 14% = 24% Step-3:Calculation of Terminal Value in Year 5 Terminal Value in Year 5 = FCF5*(1+g)/(Ke-g) Where, = 22910441.88*(1+0.04)/(0.24-0.04) FCF5 $ 2,29,10,441.88 = $ 11,91,34,297.78 g 4% Ke 24% Thus, Terminal Value in Year 5 is $ 11,91,34,297.78 or, $ 119.13 Million

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