Question

The top three members of the management team of an electronic firm purchased the company with their own personal fund and $100 million borrowing. The interest on the loan was 11% and the loan is to be paid off annually by $25 million so that by the end of year 4 the loan will be fully paid off. The unlevered cost of equity for the firm is estimated at 12% and the tax rate is 35%. The free cash flows are estimated for the next four years as follows: $50 million in year 1, $55 million in year 2, $58 million in year 3, and $60 million in year 4. The cash flow is expected to grow at 3% per year after the fourth year.

Estimate the value of the firm as of year 0 using the APV valuation method.

Answer 1

[$ in millions]	0	1	2	3	4	5------->
FCF		50.00	55.00	58.00	60.00
PVIF at 12%		0.89286	0.79719	0.71178	0.63552
PV at 12%		44.64	43.85	41.28	38.13
Sum of PV of FCF - t1 to t4	167.90
Continuing value of FCF = 60*1.03/(0.12-0.03) =						686.67
PV of continuing value = 686.67*0.63552 =	436.39
Unlevered value of FCF	604.30
Interest expense:
Beginning loan balance		100.00	75.00	50.00	25.00
Tax shield on interest at 35%		35.00	26.25	17.5	8.75
PVIF at 11%		0.90090	0.81162	0.73119	0.65873
PV of interest tax shield		31.53	21.31	12.80	5.76
Sum of PV of ITS - t1 to t4	71.40
APV = 604.30+71.40	675.69