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CMA Final · Strategic Performance Management and Business Valuation · Fundamentals of Business Valuation

Aarav Textiles is expected to generate a steady free cash flow to firm of Rs 90 lakh next year, growing at 5% per annum forever. Its WACC is 14%. What is the enterprise value using the constant growth model?

Enterprise value is Rs 1,000 lakh. Under the constant growth model it equals next year's free cash flow divided by the difference between WACC and growth, which is 90 divided by 9 percent. Ignoring growth would understate the value.

  1. ARs 900 lakhCorrect
  2. BRs 642.86 lakh
  3. CRs 1,000 lakh
  4. DRs 473.68 lakh

Explanation

Enterprise value = FCFF1 / (WACC - g) = 90 / (0.14 - 0.05) = 90 / 0.09 = Rs 1,000 lakh. Check: 1,000 x 0.09 = 90. Rs 900 lakh is wrong because it is not what the formula gives; Rs 642.86 lakh divides by WACC alone (90/0.14), ignoring growth.

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