A company forecasts free cash flows in one year to be -$10 million and free cash

Question

A company forecasts free cash flows in one year to be -$10 million and free cash flow in two years to be $20 million. After the second year, free cash flow will grow at a constant rate of 4% per year forever. The firm has $2 million in debt, $1.5 million in marketable securities, and preferred stock of $2.5 million. There are 2 million shares outstanding. If the overall cost of capital is 14 percent, what is the current value of operations, to the nearest million? What is the value of equity? What is the value of equity per share?

Explanation / Answer

Firm value in year 2 = expected FCF in 3/(cost of capital - growth)
= 20*(1+4%)/(14%-4%)
= 208 million

Firm value this year = discounted value in year 2 + discounted FCF1 and FCF2
= (208/(1+14%)^2) + (20/(1+14%)^2) + ((-10)/(1+14%))
= 166.67 million

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