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Hi JM,
For part a(i), when calculating the terminal value of Fodder’s free cash flow, the answer is: 4444 x [1.03/(0.13-0.03)] x .613 = 28,074.
If we are calculating perpetuity, shouldn’t the numerator be 1 as follows:
4444 x [1/(0.13-0.03)] x .613 = 27,242. this method is also in accordance with the technical article “Business Valuations”.Please advise.
First, we are not calculating the terminal value!!
It is the present value that we are calculating.The examiners answer is correct.
In both the answer to this question and the technical article, we are using the dividend valuation formula from the formula sheet to get the PV. (The formula can be used for any growing perpetuity).
The reason for the difference is that the numerator (Do(1+g)) is always the flow in 1 years time.
In the exam question, we know that is is 4443 in 4 years time – what we are after is the flow from 5 in perpetuity. So in the formula we use the flow in 5 years time (4443 x 1.03), and arrive at a PV in 4 years time.
Had we been told what the flow was in 5 years time, we would not have needed to multiply by 1.03.(An alternative way of getting the same result would have been to get the PV of the first three years, and then use the formula for years 4 to infinity. Since we know that at time 4 it is 4443, we would have used that in the formula (without multiplying by 1.03). That would have given a PV at time 3 and we would then have discounting it for 3 years.
If you added that to the PV of the first three years flows, you would end up with exactly the same result.)Sir why did we have to calculate the PV of the Terminal Valu if they said ‘ the growth rate of the free Cash flows will be half the initial forecast sales revenue growth rate for the FORSEEABLE FUTURE. .
If it’s the forseeable future doesn’t thatean growth isn’t going into perpetuity.‘In perpetuity’ means ‘for the foreseeable future.
(And as I wrote in my previous reply, we are not calculating terminal values!)
In the examiners mark scheme and BPP they don’t round off the DF to 3 decimal places as we are used to,instead they use the full figures. For eg (1+.09)^-1 = 0.917….. If we use the answers to 3dp we get a whole different answer where the conclusion would be not to go ahead with the acquisition as the premium paid would be greater than the synergy benefits.
So do we always have to use full figures or can we round it off ?It does not matter at all whether you round to three places or not.
The marks are for the workings and not for the final answer. What matters is that you have proved that you understand what you are doing.
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