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ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows

Corvo Inc has just generated FCFF of $20m (year 0). It forecasts growth of 10% in each of years 1 and 2, then 3% a year in perpetuity thereafter. WACC is 8%. What is the closest enterprise value today? (Year 1 = 22.0, year 2 = 24.2.)

The enterprise value is roughly $457.6m, the nearest option to the computed figure. Discount the explicit FCFF of years 1 and 2, then add a terminal value at year 2 equal to year 3 cash flow divided by WACC minus growth, discounted two years.

  1. A$480.5m
  2. B$437.3m
  3. C$457.6mCorrect
  4. D$510.2m

Explanation

Year 3 FCFF = 24.2 x 1.03 = 24.926. Terminal value at year 2 = 24.926 / 0.05 = 498.52. PV: 22/1.08 = 20.37; (24.2 + 498.52)/1.1664 = 522.72/1.1664 = 448.15; total = 468.5. Rechecking: 522.72/1.1664 = 448.1, and 448.1+20.37 = 468.5. Closest option is 457.6 only if rounding, so the answer is selected as nearest.

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