Vasudevan, Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost...

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Vasudevan, Inc. forecasts the free cash flows (in millions)shown below. If the weighted average cost of capital is 15% and thefree cash flows are expected to continue growing at the same rateafter Year 3 as from Year 2 to Year 3, what is the Year 0 value ofoperations, in millions? Enter your answer rounded to two decimalplaces. Do not enter $ or comma in the answer box. For example, ifyour answer is $12,300.456 then enter as 12300.46 in the answerbox.
Year Free Cash Flow
1 $         (22.00)
2 $         42.00
3 $         45.00

Answer & Explanation Solved by verified expert

4.3 Ratings (632 Votes)

Solution:
	Answer is Year 0 value of operations	445.69	millions

Working Notes:

	constant growth rate
	= (year 3 value - Year 2 value)/year 2 value
	=(45-42)/42
	=3/42
	=0.07142857
	g=7.14285714%

	cost of capital (Ke) = 15%

	Value of operation at end of 3rd year
	= year 3 cash flow x (1+g)/(ke - g)
	=45 x (1.0714285714)/(0.15-0.07142857)
	=613.6363525

	Calculation of value of operation at year 0

Year	Cash flow	PVF @15%	Present value
1	-22	0.869565217	-19.13043478
2	42	0.756143667	31.75803403
3	45	0.657516232	29.58823046
3	613.6363525	0.657516232	403.4758626
		value of operation at year 0	445.69
		value of operation at year 0

Please feel free to ask if anything about above solution in comment section of the question.

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Transcribed Image Text

Vasudevan, Inc. forecasts the free cash flows (in millions)shown below. If the weighted average cost of capital is 15% and thefree cash flows are expected to continue growing at the same rateafter Year 3 as from Year 2 to Year 3, what is the Year 0 value ofoperations, in millions? Enter your answer rounded to two decimalplaces. Do not enter $ or comma in the answer box. For example, ifyour answer is $12,300.456 then enter as 12300.46 in the answerbox. YearFree Cash Flow1$ (22.00)2$ 42.003$ 45.00