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Hi Mr Moffat.
In the Kaplan kit. Objective style question.
I’ll write the extracts of the question here as well.
Free cash flow of 6m next year And growing at 4 % forever. Wacc 12 percent and ke 15%. Debt is 2.5
The question ask to calculate value to equity holders.
I have couple of questions why the answer is given the way it is.
6 is divided by fraction. Why growth is not considered with number 6. 6 (1+g)
I’m using the discount factor based on cost of equity to arrive straight at value to equity holders instead of wacc. Why isn’t that even leading to the correct answer.
The correct answer is 72.5
The free cash flow is the total available for both equity and debt. Discounting this at the WACC gives the total value of the firm (equity plus debt).
To discount this we use the growth formula. g is 4% and r is 12%.
On the top of the formula is Do(1+g) where Do is the current flow and Do(1+g) is therefore the flow in 1 years time and this is given in the question as being 6M.Therefore the total MV of the firm is 6 / (0.12 – 0.04) = 75.
This is the total of equity plus debt, and since we are told that the debt is 2.5, then the equity must be 75 – 2.5 = 72.5.Ok I understand the growth part which is the value 6.
And the reason we can’t discount discount free cash flow at cost of equity to arrive at value to shareholders because fcf belongs to both debt holders and equity holders.
So basically you mean
If we started from pbit and considered interest payments and then reached at fcf. Only then we could apply cost of equity to reach at value to the shareholders right?
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