Calculate the EV of the firm today for the investor. That is, the PV of FCF1, FCF2, FCF3 and the Terminal Value.

Question

BlackTom AI · Accepted Answer

Question restatement: You are asked to calculate the enterprise value (EV) of the firm today for the investor, defined as the present value (PV) of FCF1, FCF2, FCF3, and the Terminal Value (TV).

Step 1: Identify components to discount. The total EV today is the sum of the present values of the first three forecasted free cash flows (FCF1, FCF2, FCF3) and the present value of the terminal value (TV) that captures all subsequent cash flows beyond year 3.

Step 2: Choose the discount rate. In a typical discounted cash flow model, you would use the firm’s weighted average cost of capital (WACC) as the discount rate for all unlevered free cash flows. If the problem provides a different rate, apply that consistently.

Step 3: Present value of each early-year FCF. For each year i = 1, 2, 3, calculate PV(FCF i) = FCF i / (1 + r)^i, where r is the discount rate (e.g., WACC). This reflects the time value of money and risk-adjusted returns.

Step 4: Compute the terminal value. The TV represents the value of all cash flows beyond year 3. The common formulas are:
- Perpetuity growth model: TV = FCF4 / (r − g), where FCF4 = FCF3 × (1 + g) and g is the perpetual growth rate.
- Or exit multiple approach: TV = Year3Metric × multiple, if directed by the problem.

Step 5: Discount the terminal value back to today. PV(TV) = TV / (1 + r)^3, bringing the value from year 3 into present value terms.

Step 6: Sum all present values. EV today = PV(FCF1) + PV(FCF2) + PV(FCF3) + PV(TV).

Step 7: Sanity checks and common pitfalls. Ensure consistent use of r across FCFs and TV, verify the TV calculation uses the same growth/exit assumptions as specified, and watch for sign conventions (positive cash flows vs. negative investments). If FCFs are in different units or currencies, convert appropriately before summing. If the problem provides numeric values for FCF1–FCF3, r, g, etc., plug them into these formulas to obtain the EV.

Step 8: Interpret the result. The resulting EV represents the value today of the firm’s expected future cash generation under the given assumptions. If you compare this EV to the current enterprise value or asking price, you can assess whether the investment is potentially undervalued or overvalued given the inputs.

Note on answer options: This question is numerical and expects you to compute PVs and the TV using the given FCFs and parameters. Ensure you keep units consistent throughout, and round according to the problem’s guidance (e.g., to two decimal places) when presenting intermediate sums.

If you have the specific values for FCF1, FCF2, FCF3, r, and the TV formula (growth rate g or exit multiple), I can walk you through the exact substitution and arithmetic step by step.

COMM_V 298 201-207 2024W2 Class 19: Corporate Valuation Practice Quiz

Calculate the EV of the firm today for the investor. That is, the PV of FCF1, FCF2, FCF3 and the Terminal Value.

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