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Terminal and Firm Valuation Using Free Cash Flow

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The following free cash flows (in $ Million) are projected for the next five years. The free cash flows are expected to grow at a stable rate of 7% for every year after year 5. The opportunity cost of capital is 10%.

Year 1/Free Cash Flow is 5
Year 2/Free Cash Flow is 12
Year 3/Free Cash Flow is 24
Year 4/Free Cash Flow is 44
Year 5/Free Cash Flow is 69

1. Calculate the terminal value of the firm at the end of year 5. (Show Work)

2. Calculate the current value of the firm using the constant growth model after year 5. (Show Work)

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Solution Preview

a. The terminal value of a firm is computed by dividing the Free Cash Flow at the end of the year after the last year considered by the excess of the return over the growth rate. (This is the formula for a perpetual annuity, as well.) Thus, in this ...

Solution Summary

This solution discusses and demonstrates, in detail, the determination of the terminal value (sometimes called the "horizon value") and its use in computing the firm's value.