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.

#### You've reached the end of your free preview.

Want to read all 60 pages?

- Spring '14
- Time Value Of Money, Net Present Value