The free cash flows in the table below are estimates for a medium-sized enterpri

Question

The free cash flows in the table below are estimates for a medium-sized enterprise based in Buenos Aires, Argentina. Your employer is interested in purchasing this firm, and wants you to figure out what it is worth in U.S. dollars. The national currency of Argentina is the peso, and the free cash flow estimates in the table below are all in that local currency (assume that the 2016 cash flow is exactly one year away, and that all cash flows after 2019 grow at 4% forever). As of the beginning of 2016, 1 Argentina peso is worth 7.1 U.S. cents. In the table below are forward one-year interest rates for both Argentina and the U.S. Assume that U.S. dollar cash flows can be discounted at the cost of equity, because the firm in question has no debt. The appropriate risk free rate is 3%, the market risk premium is 7%, and the firm's beta is 1.6. To account for country-specific risk related to an Argentinian investment, analysts in the U.S add 4 percentage points to the CAPM-derived cost of equity. What is this firm worth in U.S. dollars? (U.S.S62.3 million)

Explanation / Answer

cost of equity = Risk free rate +(market risk premium)*beta

= 0.03+( 0.07)*1.6

=14.20%

Analyst in US add 4% to CAPM derived cost of equity to account country specific risk.hence discount rate is 18.20%(14.20+4)

cashflow in 2020 = cashflow in 2019*104%

=2384926893*104%

= 2480323969

since after 2019 cash flow grows forever by 4% and discount rate is 18.20% the present value of future cashflows in year 2019 is :-(growing perpectuity)

=cashflow next year/(discount rate-growth rate)

=2480323969/(0.1820-0.04)

=17467070204

Worth of the firm is $160314853.

Year Free cashflow (in pesos) Peso/cent rate Free cashflow (in cents) 2019 PV of future cashflows (in cents) Total cashflows (in cents) Discount factor @18.20% Discounted cashflow 2016 521146285 5.83 3038282842 3038282842                                         0.846 2570459257 2017 526854718 4.79 2523634099 2523634099                                         0.716 1806306455 2018 628551474 3.9 2451350749 2451350749                                         0.606 1484407112 2019 745289654 3.2 2384926893 17467070204 19851997097                                         0.512 10170312483 NPV (in cent) 16031485307 NPV (in $) 160314853

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