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Hi Tutor,
Kindly clarify these further, i know that the calculation for a company’s value using FCF model is FCF(1+g)/(Ko – g).
1) Why did the examiner use FCF(1+g)/Ko, in his calculation of estimated value of the manufacturing unit of Chrysos in the Management buy-out option and then used FCF(1+g)/(Ko – g), while calculating the value of Chrysos after the restructuring.2) In estimating the equity value of Chrysos, after getting the corporate value, since the capital structure is 20% debt and 80% equity, i multiplied the corporate value by 80% to get the estimated value of equity, but the examiner deducted the share capital of $1800.WHY?? I got confused because if at all it will be the share capital then it should have been (1800+600) that is the converted unsecured bonds from the VCOs because that is the figure used in the extract financial position.
I anticipate your swift response. Many thanks.
We only use the formula to get the value when the free cash flows are an inflating perpetuity – in that case the formula is giving the present value. In other cases we calculate the present value by discounting the free cash flows as normal.
1. The question specifically says that for the MBO, then cash flows will increase by 8% in the first year only. Therefore there is a constant flow of 435M x 1.08 in perpetuity and we discount this in the normal way for a perpetuity by multiplying by 1/0.1
For the mining and shipping unit, the question says that the cash flows will inflate at 4% p.a. in perpetuity, and therefore we can use the formula.2. The 1800M is not the equity – it is the bank overdraft that is converted into long-term debt (the existing long-term debt is converted into share and the other non-current liabilities are repaid).
(With regard to a swift response, we do not sit at the computer 24 hours a day 🙂 I answer questions twice a day 🙂 )
Many thanks, Mr John. My apologies on the swift response request. I appreciate all your efforts. I understand better now.
Thanks.
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