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)	83,000	50,000	61,000	39,000	70,000

After then, the free cash flows are expected to grow at the industry average of 9% per year. Using the discounted free cash flow model and a weighted average cost of capital of 15%:

Estimate the enterprise value of Heavy Metal.

 

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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) = 70,000*(1+0.09) / (0.15– 0.09)
  = $1,271,666.67
• 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)=83,000 / (1+0.15)¹ + 50,000 / (1+0.15)² + 61,000 / (1+0.15)³ + 39,000 / (1+0.15)⁴ + (70,000 + 1,271,667) / (1+0.15)⁵ = 839,433

This gives you the enterprise value of the company based on its free cash flows.