Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:
| Year | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|
| FCF ($ million) | 27,000 | 78,000 | 71,000 | 89,000 | 53,000 |
After then, the free cash flows are expected to grow at the industry average of 10% per year. Using the discounted free cash flow model and a weighted average cost of capital of 11%:
Estimate the enterprise value of Heavy Metal.
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Answers Below. Scroll down to view. SOLUTION:
The process for solving this problem is very similar to the supernormal stock valuation process.
- Step 1: Find the value of the company once the free cash flows stabilize using the discounted cash flow technique.
V(5) = CF(5)(1+g) / (wacc–g)
V(5) = 53,000*(1+0.10) / (0.11– 0.10)
= $5,830,000.00 - Step 2: Find the present value of all of the free cash flows plus the present value of the company value from the last step.
V(0)=27,000 / (1+0.11)1 + 78,000 / (1+0.11)2 + 71,000 / (1+0.11)3 + 89,000 / (1+0.11)4 + (53,000 + 5,830,000) / (1+0.11)5 = 3,689,447
This gives you the enterprise value of the company based on its free cash flows.