FIN 640 Question

Question

Assume your firm net cash flows for the next three years are projected at $72,000, $78,000, and $84,000, respectively. After that the cash flows are expected to increase by 3.2 percent annually. The aftertax cost of debt is 6.2 percent and the cost of equity is 11.4 percent. What is the value of your firm if it is financed with 40 percent debt and 60 percent equity?

Answer 1

Create an annual cash flow stream for the valuation period.  20, 30, 40 years.  Whatever the period is

 

You have the first three years and each subsequent year increases by 3.2  percent. 

 

Split the cash flow into two pieces. The first will be 40% of each annual amont    The second will be the remaining 60%. 

 

Take the present value of the first stream  using 6.2 as the discount rate. This will give you the debt value

 

Take the present value of the second stream using 11.4% as the discount rate.  This will be the equity value 

 

The combination will give the total value

 

Hope this helps

 

Tom