Page 273 - AFM Integrated Workbook STUDENT S18-J19

Business valuation

Illustration 1

Wars Co has a planning horizon of three years, during which it has forecast
that free cash flows will be $2 million, $3 million and $5 million respectively.

After the planning horizon the free cash flows are expected to stay constant
into perpetuity.

Wars Co has some debt finance in its capital structure, with a market value of
$8 million, and it has $1 million worth of short term investments.

The company’s cost of capital is 10%.

Required:

Calculate the value of the company’s equity, using the free cash flow
method.

Solution

$m T 1 T 2 T 3 T 4
onwards

FCF 2 3 5 5

DF 10% 0.909 0.826 0.751 (1/0.10)
x 0.751

PV 1.818 2.478 3.755 37.550

Overall PV = $45.6 million

So value of equity = $45.6m + $1m (ST investments) - $8m (debt value)

= $38.6 million

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