The MoMi Corporation’s income before interest, depreciation and taxes, was $3.2
ID: 2783383 • Letter: T
Question
The MoMi Corporation’s income before interest, depreciation and taxes, was $3.2 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 20% of pretax cash flow each year. The tax rate is 35%. Depreciation was $380,000 in the year just ended and is expected to grow at the same rate as the operating cash flow. The appropriate market capitalization rate for the unleveraged cash flow is 12% per year, and the firm currently has debt of $5 million outstanding. Use the free cash flow approach to calculate the value of the firm and the firm’s equity.
Explanation / Answer
A. Before Tax and interest tax flow from operations (3.2 million x 5%) $1,600,000
B. Depreciation (380000 x 5% + 380,000) $395,000
C. Taxable Income (A-B) $1,205,000
D. Taxes (@35%) $421,750
E. After-tax unleveraged income $783,250
F. After-tax cash flow from operations
(After-tax unleveraged income + depreciation) $1,178,250
G. New investment (20% of cash flow from operations) $320,000
H. Free cash flow
(After tax flow from operations - new investment) $858,250
The Value of the firm (i.e. debt plus equity) is:
V0 = C1 / k-g = 858,250/0.12-0.05 = 1,226,0714.28
Since the Value of debt is $ 5 million, the value of equity is 7,260,714.28.