Suppose that a firm has, as of this year, an Earnings Before Interest and Taxes

Question

Suppose that a firm has, as of this year, an Earnings Before Interest and Taxes of $117 million, Depreciation of $10 million, has bought $25 million in machinery, has sold $12 million in old machinery for cash, has had an increase in Accounts Receivables by $3 million, an increase in (all) Current Liabilities by $4 million, an increase in interest-bearing Current Liabilities of $3 million, an increase in non-interest-bearing Current Liabilities of $1 million, has 7.25 million shares of common stock outstanding, has 1 million shares of preferred stock outstanding each with a par value of $35, and total long term debt worth $55 million. Also, this firm has a Weighted Average Cost of Capital of 12% and the firm's Free Cash Flows grow at a constant, annual rate of 6%. How much is this firm's residual, or Common value currently worth?

$413.38 million

$581.18 million

$804.91 million

$1,103.21 million

$413.38 million

$581.18 million

$804.91 million

$1,103.21 million

Explanation / Answer

we know that the Free cash flows = EBIT (1-tax rate) + depreciation - net working capital - capital expenditure

Here there is no tax rate given , therefore tax rate = 0%

Depreciation = $10 million

and Net Capital expenditure = Purchese of New machinery - sale of old machinery = $25 million - $12 million

new capital expenditure = $13 million

Also Net working capital = Increase in accounts receivables - Increase in accounts payables

NWC = $3 million - $4 million = -$1 million

Hence Free Cash Flows = $(117 + $10 +$1 - $13) million = $115 million

Weighted average cost of capital = 12%

and growth in free cash flows = 6%

Hence Value of residual equity = $115 million / (12% - 6%) = $2031.67 million

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