Question #75 - Reading 21 Free Cash Flow Valuation

Reading: Reading 21 Free Cash Flow Valuation

PDF File: Reading 21 Free Cash Flow Valuation.pdf

Page: 36

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Shared Context

- If FCInv equals Fixed Capital Investment and WCInv equals Working Capital Investment, which statement about FCF and its components is least accurate? A) FCFE = (EBIT × (1 − tax rate)) + Depreciation − FCInv − WCInv. B) FCFF = (EBITDA × (1 − tax rate)) + (Depreciation × tax rate) − FCInv − WCInv. C) WCInv is the change in the working capital accounts, excluding cash and short-term borrowings.

Question

Given Nguyen's estimate of Country Point's terminal value in 2008, what is the growth assumption she must have used for free cash flow after 2008?

Answer Choices:

A. 3%

B. 7%

C. 9%

Explanation

We know the terminal value in 2008 is $223.7 million. We can calculate the free cash flow in 2008 to be $23 million (= $30 million net income + $5 million depreciation − $12 million capital expenditures). (See the table in question 1). Thus, we can solve for the estimated growth rate: Terminal value = [CF@2008 × (growth rate + 1)] / (discount rate − growth rate) 223.7 million = ($23 million × (growth rate + 1)) / (0.18 − growth rate) 223.7 million × (0.18 − growth rate) = 23 million × (growth rate + 1) 40.266 − (223.7 × growth rate) = 23 million + (23 × growth rate) 17.266 = 246.7 × (growth rate) growth rate = 0.07 Nguyen's growth rate assumption is 7% per year

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