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A company’s current revenues and costs are as follows: sales $200 million, cost of sales $110 million, distribution and administrative expenses are $20 million, tax allowable depreciation $40 million and annual capital spending is $50 million. Corporation tax is 30%. The current value of debt is $17 million.
The WACC is 14.4%. Inflation is 4%.
These cash flows are expected to continue every year for the foreseeable future.
Calculate value of equityMy doubt is y are we using real rate to discount the cash flows rather than using the given wacc?
To discount at the nominal/actual WACC we would need the nominal/actual cash flows, which would mean applying the inflation rate to the current revenues and costs.
If the flows were only for (say 5 years) then we can do this (and normally would in exam questions), and then discount for each year separately at the nominal WACC.However, because the flows are in perpetuity, it is impossible to calculate the actual cash flows for each year. When it is a perpetuity we have no choice but to discount the current price flows are the real cost of capital.
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