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ACCA Strategic Professional · Advanced Financial Management · Valuation for acquisitions and mergers

Aster Co has next year's FCFF of $300m, interest expense of $40m, tax rate 25% and expects net new borrowing of $20m. FCFE is expected to grow at 3% a year in perpetuity and the cost of equity is 12%. Using the FCFE model, what is the value of equity, to the nearest $0.1m?

Equity is worth $3,222.2m. FCFE is FCFF of 300, less after-tax interest of 30, plus net new borrowing of 20, giving $290m. Dividing by cost of equity less growth, 9%, gives the value. Equity cash flows are discounted at the cost of equity, not WACC.

  1. A$3,222.2mCorrect
  2. B$3,111.1m
  3. C$2,777.8m
  4. D$3,333.3m

Explanation

FCFE = FCFF - interest x (1 - t) + net borrowing = 300 - 30 + 20 = $290m. Equity value = 290 / (0.12 - 0.03) = $3,222.2m. Using pre-tax interest gives FCFE of 280 and $3,111.1m, which is wrong because interest is tax deductible. Deducting the borrowing gives $2,777.8m, which is also wrong.

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