ACCA Applied Skills · Financial Management · Nature and purpose of the valuation of business and financial assets
Kestrel Co expects free cash flows to the firm of $4.0m in one year's time, growing at 3% a year in perpetuity. Its WACC is 11%. Kestrel has debt with a market value of $15m. What is the value of Kestrel's equity?
Value the firm as 4.0 divided by (11% less 3%), giving $50m. Deduct the $15m market value of debt to arrive at an equity value of $35m. Debt must be subtracted because free cash flow to the firm belongs to all providers of finance.
- A$35.0mCorrect
- B$36.5m
- C$50.0m
- D$51.5m
Explanation
Firm value = 4.0 / (0.11 - 0.03) = 4.0/0.08 = $50.0m. Equity = 50.0 - 15.0 = $35.0m. Check: 35 + 15 = 50. Distractor $50.0m forgets to deduct debt; $36.5m uses wrong gain; $51.5m adds debt.
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