The MoMi Corporation’s income before interest, depreciation and taxes, was $2.2

Question

The MoMi Corporation’s income before interest, depreciation and taxes, was $2.2 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 16% of pretax cash flow each year. The tax rate is 30%. Depreciation was $280,000 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 10% per year, and the firm currently has debt of $6 million outstanding. Use the free cash flow approach to calculate the value of the firm and the firm’s equity.

Explanation / Answer

Before tax,depreciation,interest cash flow from operations for next year=2.2*10^6*(1+5%)=2310000

Depreciation=280000*(1+5%)=294000

Taxable income=2310000-294000=2016000

Taxes(30%)=30%*2016000=604800

Net income=2016000-604800=1411200

Cash flow from operations=Net income+Depreciation

=1411200+294000=1705200

New investment=20%*2310000=462000

Free cash flow=1705200-462000=1243200

Value of firm=FCFF1/(k-g)

=1243200/(10%-5%)

=24864000

Value of equity=value of firm-debt

=24864000-(6*10^6)

=18864000

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