The MoMi Corporation’s cash flow from operations before interest and taxes was $
ID: 2786625 • Letter: T
Question
The MoMi Corporation’s cash flow from operations before interest and taxes was $2.4 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 18% of pretax cash flow each year. The tax rate is 35%. Depreciation was $220,000 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 9% per year, and the firm currently has debt of $4.2 million outstanding. Use the free cash flow approach to value the firm’s equity. (Enter your answer in dollars not in millions.)
What is the Value of the equity?
Explanation / Answer
Operating Cash flow before interest & tax
$ 2,520,000
Less: Depreciation
$ 231,000
Taxable Income
$ 2,289,000
Less: Tax @ 35 %
$ 801,150
After tax unlevered income
$ 1,487,850
After tax cash flow from operation
$ 1,718,850
Less: New investment
$ 453,600
Free cash flow
$ 1,265,250
Value of the firm, V0 = C1/k-g
= $ 1,265,250/9 % - 5 %
= $ 1,265,250/4 %
= $ 1,265,250/0.04
= $ 31,631,250
Value of the firm = debt + equity
$ 31,631,250 = $ 4,200,000 + equity
Equity = $ 31,631,250 - $ 4,200,000
= $ 27,431,250
Value of equity is $ 27,431,250.
Explanation for above table:
Operating Cash flow before interest & tax = $ 2,400,000 x 1.05 = $ 2,520,000
Depreciation = $ 220,000 x 1.05 = $ 231,000
Tax = $ 2,289,000 x 0.35 = $ 801,150
After tax cash flow from operation = after tax unlevered income + Depreciation
= $ 1,487,850 + $ 231,000 = $ 1,718,850
New investment = $ 2,520,000 x 0.18 = 453,600
Operating Cash flow before interest & tax
$ 2,520,000
Less: Depreciation
$ 231,000
Taxable Income
$ 2,289,000
Less: Tax @ 35 %
$ 801,150
After tax unlevered income
$ 1,487,850
After tax cash flow from operation
$ 1,718,850
Less: New investment
$ 453,600
Free cash flow
$ 1,265,250