Kinkead Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million, but its FCF at t = 2 will be $20 mi

Kinkead Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm’s value of operations, in millions?
Select one:
a. $158
b. $167
c. $175
d. $184
e. $193

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  1. Answer:

    correct option is b. $167

    Explanation:

    given data

    free cash flow FCF 1 = -$10 million

    t = 1

    free cash flow FCF 2= $20 million

    t = 2

    FCF grow rate = 4%

    average cost of capital = 14%

    to find out

    what is the firm’s value of operations

    solution

    first we get here firm value in year 2 that is express as

    firm value in year 2 = expected FCF in 3 ÷ (cost of capital – growth)    ………1

    put here value

    firm value in year 2 = [tex]\frac{20*(1+0.04)}{0.14 – 0.04}[/tex]

    firm value in year 2 = 208 million

    and

    firm value of operation this year will be as

    firm value = discounted value in year 2 + discounted FCF1 and FCF2     ………….2

    firm value = [tex]\frac{208}{(1+0.14)^2} +\frac{20}{(1+0.14)^2} +\frac{-10}{(1+0.14)}[/tex]

    firm value = 166.67 = 167 million

    so correct option is b. $167

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