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  1. business
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  3. your firm would like to evaluate a proposed new op

Your firm would like to evaluate a proposed new operating division. You have forecasted cash...

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Accounting

Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows for this division for the next five years, and have estimated that the cost of capital is 13 %. You would like to estimate a continuation value. You have made the following forecasts for the last year of your five-year forecasting horizon (in millions of dollars):

Year 5

Revenues $279.4

Operating income 68.8

Net income 44.7

Free cash flows 108.3

Book value of equity 240.7

Note: Assume that all firms (including yours) have no debt.

a. You forecast that future free cash flows after year 5 will grow at 4 % per year, forever. Estimate the continuation value in year 5, using the perpetuity with growth formula.

b. You have identified several firms in the same industry as your operating division. The average P/E ratio for these firms is 23. Estimate the continuation value assuming the P/E ratio for your division in year 5 will be the same as the average P/E ratio for the comparable firms today.

c. The average market/book ratio for the comparable firms is 3.7. Estimate the continuation value using the market/book ratio.

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