Tomkat Corp. has only a single asset. This asset generates operating cash flow of $200,000 per year,...

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Tomkat Corp. has only a single asset. This assetgenerates operating cash flow of $200,000 per year, inperpetuity. Tomkat also has a single liability,which is a perpetual bond (the maturity date is infinitely far inthe future) that has a face value of $1 million and that payscoupon interest at a rate of 8% once per year. Theappropriate discount rate for all cash flows in this problem is 10%per year. (a) What is the value of Tomkat’s equity? Assume now,that in addition to the asset and liability described above, Tomkatis working on a new project. The project requiresan immediate investment of $400,000, and will require anotherinvestment of $600,000 a year from now. Two years fromnow the project will generate a positive operating cash flow of$60,000, and subsequent operating cash flows will grow by 5% peryear in perpetuity. Continue to assume a discount rateof 10% per year. (b) What is the value of Tomkat’s equity given theexistence of this “growth opportunity”?

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4.4 Ratings (778 Votes)

A	B	C	D	E
2
3
4
5		Operating cash flow	200000
6		Interest	80000
7		Free cash flow to equity	120000
8		Discount rate	10%
9	a)	Value of equity	1200000
10
11	b)
12		Growth	5%
13		Discount rate	10%
14		Operating cash flow	60000
15		PV of operating cash flow	1090909.091
16		NPV	145454.5455
17
18		Value of equity	1345454.55
19
20

A	B	C	D	E
2
3
4
5		Operating cash flow	200000
6		Interest	=1000000*8%
7		Free cash flow to equity	=D5-D6
8		Discount rate	0.1
9	a)	Value of equity	=D7/D8
10
11	b)
12		Growth	0.05
13		Discount rate	0.1
14		Operating cash flow	60000
15		PV of operating cash flow	=D14/((D13-D12)*(1+10%))
16		NPV	=D15-600000/1.1-400000
17
18		Value of equity	=D9+D16
19
20

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Transcribed Image Text

Tomkat Corp. has only a single asset. This assetgenerates operating cash flow of $200,000 per year, inperpetuity. Tomkat also has a single liability,which is a perpetual bond (the maturity date is infinitely far inthe future) that has a face value of $1 million and that payscoupon interest at a rate of 8% once per year. Theappropriate discount rate for all cash flows in this problem is 10%per year. (a) What is the value of Tomkat’s equity? Assume now,that in addition to the asset and liability described above, Tomkatis working on a new project. The project requiresan immediate investment of $400,000, and will require anotherinvestment of $600,000 a year from now. Two years fromnow the project will generate a positive operating cash flow of$60,000, and subsequent operating cash flows will grow by 5% peryear in perpetuity. Continue to assume a discount rateof 10% per year. (b) What is the value of Tomkat’s equity given theexistence of this “growth opportunity”?