You would like to estimate a continuation value. You have made the following forecasts for the last year of your five-year forecasting horizon (in millions of dollars): a. You forecast that future free cash flows after year 5 will grow at 2% per year, forever. Estimate the continuation value in year 5, using the perpetuity with growth formula. b. You have identified several firms in the same industry as your operating division. The average P/E ratio for these firms is 30. Estimate the continuation value assuming the P/E ratio for your division in year 5 will be the same as the average P/E ratio for the comparable firms today. c. The average market/book ratio for the comparable firms is 4.0. Estimate the continuation value using the market/book ratio. a. FCF in year 6 = 110 × 1.02 = 112.2 Continuation Value in year 5 = 112.2 / (12% – 2%) = $1,122. $1,386,440

b. We can estimate the continuation value as follows: Continuation Value in year 5 = (Earnings in year 5) × (P/E ratio in year 5) = $50 × 30 = $1500. c. We can estimate the continuation value as follows: Continuation Value in year 5 = (Book value in year 5) × (M/B ratio in year 5) = $400 × 4 = $1600. 8-21. Using the FCF projections in part b of Problem 11, calculate the NPV of the HomeNet project assuming a cost of capital of a. 10%. b. 12%. c. 14%. What is the IRR of the project in this case? a. Year 0 1 2 3 4 5 Net Present Value ($000s) 1 Free Cash Flow (16,500) 2,470 6,580 10,421 12,860 3,843 2 Project Cost of Capital 10% 3 Discount Factor 1.000 0.909 0.826 0.751 0.683 0.621 Year 0 1 2 3 4 5 1 PV of Free Cash Flow (16,500) 2,245 5,438 7,830 8,783 2,386 2 NPV 10,182 3 IRR 28.8% b. Year 0 1 2 3 4 5 Net Present Value ($000s) 1 Free Cash Flow (16,500) 2,470 6,580 10,421 12,860 3,843 2 Project Cost of Capital 12% 3 Discount Factor 1.000 0.893 0.797 0.712 0.636 0.567 Year 0 1 2 3 4 5 1 PV of Free Cash Flow (16,500) 2,205 5,246 7,418 8,172 2,181 2 NPV 8,722 3 IRR 28.8% c. Year 0 1 2 3 4 5 Net Present Value ($000s) 1 Free Cash Flow (16,500) 2,470 6,580 10,421 12,860 3,843 2 Project Cost of Capital 14% 3 Discount Factor 1.000 0.877 0.769 0.675 0.592 0.519 Year 0 1 2 3 4 5 1 PV of Free Cash Flow (16,500) 2,167 5,063 7,034 7,614 1,996 2 NPV 7,374 3 IRR 28.8%

8-23.* Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars): a. For this base-case scenario, what is the NPV of the plant to manufacture lightweight trucks? b. Based on input from the marketing department, Bauer is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. What is the NPV of this project if revenues are 10% higher than forecast? What is the NPV if revenues are 10% lower than forecast? c. Rather than assuming that cash flows for this project are constant, management would like to explore the sensitivity of its analysis to possible growth in revenues and operating expenses.