CHAPTER 6

MEASURING CONTINUING VALUE USING

THE CONSTANT-GROWTH PERPETUITY MODEL
EXERCISES AND PROBLEMS

P6.1 Present Value Weighted Average Growth Rate:

a.

Discounted Cash Flow Valuation

Cost of Capital 10.0%
Growth Rate for Free Cash Flow for Continuing Value 3.0%
Millions of Dollars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 CVFirm
Unlevered Free Cash Flow for Continuing Value $ 494
Discount Factor for Continuing Value 14.286
Unlevered Free Cash Flow and Continuing Value $ 200 $ 240 $ 300 $ 420 $ 480 $ 7,063
Discount Factor 0.909 0.826 0.751 0.683 0.621 0.621
Present Value $ 182 $ 198 $ 225 $ 287 $ 298 $ 4,385
Value of the Firm as of 2011 $ 5,576 FCF1 $200
gr  0.1   6.41%
Present Value Weighted Average Growth Rate 6.41% V0 $5,576

b.

Discounted Cash Flow Valuation

Cost of Capital 10.0%
Growth Rate for Free Cash Flow for Continuing Value -3.0%
Millions of Dollars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 CVFirm
Unlevered Free Cash Flow for Continuing Value $ 466
Discount Factor for Continuing Value 7.692
Unlevered Free Cash Flow and Continuing Value $ 200 $ 240 $ 300 $ 420 $ 480 $ 3,582
Discount Factor 0.909 0.826 0.751 0.683 0.621 0.621
Present Value $ 182 $ 198 $ 225 $ 287 $ 298 $ 2,224
Value of the Firm as of 2011 $ 3,414
FCF1 $200
gr  0.1   4.14%
Present Value Weighted Average Growth Rate 4.14% V0 $2,884

©Cambridge Business Publishers, 2014

1 Corporate Valuation: Theory, Evidence & Practice, 1st Edition
P6.2 Present Value Weighted Average Growth Rate:

a.

Discounted Cash Flow Valuation

Cost of Capital 10.0%
Growth Rate for Free Cash Flow for Continuing Value 3.0%
Millions of Dollars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 CVFirm
Unlevered Free Cash Flow for Continuing Value $ 5,150
Discount Factor for Continuing Value 14.286
Unlevered Free Cash Flow and Continuing Value $ 2,000 $ -3,000 $ 3,000 $ 3,900 $ 5,000 $ 73,571
Discount Factor 0.909 0.826 0.751 0.683 0.621 0.621
Present Value $ 1,818 $ -2,479 $ 2,254 $ 2,664 $ 3,105 $ 45,682
Value of the Firm as of 2011 $ 53,043 FCF1 $2,000
gr  0.1   6.23%
Present Value Weighted Average Growth Rate 6.23%
V0 $53, 043

b.

Discounted Cash Flow Valuation

Cost of Capital 10.0%
Growth Rate for Free Cash Flow for Continuing Value -3.0%
Millions of Dollars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 CVFirm
Unlevered Free Cash Flow for Continuing Value $ 4,850
Discount Factor for Continuing Value 7.692
Unlevered Free Cash Flow and Continuing Value $ 2,000 $ -3,000 $ 3,000 $ 3,900 $ 5,000 $ 37,308
Discount Factor 0.909 0.826 0.751 0.683 0.621 0.621
Present Value $ 1,818 $ -2,479 $ 2,254 $ 2,664 $ 3,105 $ 23,165
Value of the Firm as of 2011 $ 30,526
FCF1 $2,000
gr  0.1   3.45%
Present Value Weighted Average Growth Rate 3.45% V0 $30,526

©Cambridge Business Publishers, 2014

Solutions Manual, Chapter 6 2
P6.3 Present Value Weighted Average Growth Rate:

a. and b.

Discounted Cash Flow Valuation

Cost of Capital 10.0%
Year 0 Free Cash Flow $ 231.0

Growth Rates 60% 20% 10% 5% 5% 3.0%

Millions of Dollars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 CVFirm
Unlevered Free Cash Flow for Continuing Value $ 554
Discount Factor for Continuing Value 14.286
Unlevered Free Cash Flow and Continuing Value $ 370 $ 444 $ 488 $ 512 $ 538 $ 7,915
Discount Factor 0.909 0.826 0.751 0.683 0.621 0.621
Present Value $ 336 $ 367 $ 367 $ 350 $ 334 $ 4,914
Value of the Firm as of 2011 $ 6,667
FCF1 $231
gr  0.1   4.46%
Present Value Weighted Average Growth Rate 4.46% V0 $6, 667

1 r 1.1
gA  1   1  0.0632
6.32%
FCF0 $231
1 1
VF, 0 $6, 667

P6.4 Two-Stage Growth Rate:

Discount Rate is 9%
g2 after Year 10
g1 (through Year N) -3% 0% 3%
5% 1.4% 2.4% 3.8%
10% 3.3% 4.2% 5.2%
15% 4.8% 5.5% 6.3%

©Cambridge Business Publishers, 2014

3 Corporate Valuation: Theory, Evidence & Practice, 1st Edition
P6.5 Estimating a Perpetual Growth Rate from Comparable Companies:

(Dollars in millions)
Expected Unlevered Free Cash Flow Firm Growth
WACC Year 1 Year 2 Year 3 Value Rate

Comparable Company 1 10.50% $2,000.0 $2,400.0 $2,600.0 $30,000.0 2.38%

Comparable Company 2 10.20% $340.0 $350.0 $360.0 $4,200.0 1.97%
Comparable Company 3 10.10% $200.0 $210.0 $240.0 $2,800.0 2.00%
Comparable Company 4 9.80% $1,200.0 $1,400.0 $1,500.0 $20,000.0 2.79%
Comparable Company 5 9.50% $260.0 $250.0 $250.0 $2,870.0 0.90%

25th Percentile 1.97%

Median 2.00%
75th Percentile 2.38%
Calculation for Company 5
FCFT 9.50%
g = rWACC 
 FCFt  $ 250.0
(1+ rWACC ) T-1×  VF, t-1   t=1
T-1
t 
 (1+rWACC ) 

$250
#VALUE!
g  .095   0.009 #VALUE!
2  $260 $250 
(1.095) ×  $2,870  
(1.095)1 (1.095) 2 
#VALUE!


©Cambridge Business Publishers, 2014

Solutions Manual, Chapter 6 4
P6.6 Lumpy Capital Expenditures:

We calculate the capital expenditure annuity as follows. The schedules below provide
the solution to the remaining questions.

$3, 200 $1, 200 $1, 200

PVCAPEX,0 3
 
A  1.12 1.122 1.121  $1, 792.7
1 1 1 1 1 1
   
r r 1  r  3
.12 .12 1.123

Income Statement, Balance Sheet, and Free Cash Flow Forecasts

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Revenue $ 1,600 $ 2,200 $ 2,800 $ 2,800 $ 2,800 $ 2,800
Depreciation Expense -1,067 -1,467 -1,867 -1,867 -1,867 -1,867
Income Before Taxes $ 533 $ 733 $ 933 $ 933 $ 933 $ 933
Income Tax Expense (Provision) -213 -293 -373 -373 -373 -373
Net Income $ 320 $ 440 $ 560 $ 560 $ 560 $ 560

Total Assets = Fixed Asset $ 3,200 $ 3,333 $ 3,067 $ 4,400 $ 3,733 $ 3,067 $ 4,400

Shareholders' Equity $ 3,200 $ 3,333 $ 3,067 $ 4,400 $ 3,733 $ 3,067 $ 4,400

Earnings Before Interest and Taxes $ 533 $ 733 $ 933 $ 933 $ 933 $ 933
Income Taxes Paid on EBIT -213 -293 -373 -373 -373 -373
Earnings Before Interest and After Taxes $ 320 $ 440 $ 560 $ 560 $ 560 $ 560
Depreciation 1,067 1,467 1,867 1,867 1,867 1,867
Unlevered Cash Flow from Operations 1,387 1,907 2,427 2,427 2,427 2,427
Capital Expenditures -3,200 -1,200 -1,200 -3,200 -1,200 -1,200 -3,200
Unlevered Free Cash Flow = Equity FCF $ 187 $ 707 $ -773 $ 1,227 $ 1,227 $ -773

Property, Plant and Equipment and Accumulated Depreciation Forecasts

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Beginning Property, Plant & Equipment $ 3,200 $ 4,400 $ 5,600 $ 5,600 $ 5,600 $ 5,600
Capital Expenditures 3,200 1,200 1,200 3,200 1,200 1,200 3,200
Retirements -3,200 -1,200 -1,200 -3,200
Ending Property, Plant & Equipment $ 3,200 $ 4,400 $ 5,600 $ 5,600 $ 5,600 $ 5,600 $ 5,600

Beginning Accumulated Depreciation $ 0 $ 1,067 $ 2,533 $ 1,200 $ 1,867 $ 2,533

Depreciation Expense 1,067 1,467 1,867 1,867 1,867 1,867
Retirements 0 0 -3,200 -1,200 -1,200 -3,200
Ending Accumulated Depreciation $ 0 $ 1,067 $ 2,533 $ 1,200 $ 1,867 $ 2,533 $ 1,200

Net Property, Plant and Equipment $ 3,200 $ 3,333 $ 3,067 $ 4,400 $ 3,733 $ 3,067 $ 4,400

©Cambridge Business Publishers, 2014

5 Corporate Valuation: Theory, Evidence & Practice, 1st Edition
 Discounted Cash Flow Valuation Using Actual Free Cash Flows
Year (t) 0 1 2 3 4 5 6
Free Cash Flow $ 187 $ 707 $ -773 $ 1,227 $ 1,227 $ -773

Continuing Value at Year 0 $ 5,258 $ -5,137 $ 7,276 $ 6,496 $ -3,657

Present Value of FCF Year +1 to t Correct $ 167 $ 730 $ 180 $ 959 $ 1,655
Value of the Firm at Year 0 $ 3,940 $ 5,425 $ -4,407 $ 7,456 $ 7,456 $ -2,002

Error in the Valuation 38% -212% 89% 89% -151%

Discounted Cash Flow Valuation Using Adjusted Free Cash Flows, Adjusted for Annuity Capital
Expenditures
Year (t) 0 1 2 3 4 5 6

Actual Capital Expenditure $ 1,200 $ 1,200 $ 3,200 $ 1,200 $ 1,200 $ 3,200

Annuity for Capital Expenditures 1,793 1,793 1,793 1,793 1,793 1,793
Adjustment to Free Cash Flow $ -593 $ -593 $ 1,407 $ -593 $ -593 $ 1,407
Actual Free Cash Flow 187 707 -773 1,227 1,227 -773
Adjusted Free Cash Flow $ -406 $ 114 $ 634 $ 634 $ 634 $ 634

Continuing Value at Year 0 $ 848 $ 4,212 $ 3,760 $ 3,357 $ 2,998

Present Value of FCF Year +1 to t Correct $ -363 $ -272 $ 180 $ 582 $ 942
Value of the Firm at Year 0 $ 3,940 $ 485 $ 3,940 $ 3,940 $ 3,940 $ 3,940

Error in the Valuation -88% 0% 0% 0% 0%

P6.7 Growth and Value Creation:

Discount Rate 15.00%

FCF0 $ 12,000.00
Inflation 3.0%

% Change
-1
I% ROI Inlation (i) FCF1 gFCF [r - gFCF] V0 in V0
0% 3.0% $ 12,360.0 3.0% 8.33 $ 103,000.0 Base

20% 10.0% 3.0% $ 9,888.0 4.4% 9.43 $ 93,283.0 -9.4%

20% 15.0% 3.0% $ 9,888.0 5.4% 10.42 $ 103,000.0 0.0%
20% 20.0% 3.0% $ 9,888.0 6.4% 11.63 $ 114,976.7 11.6%

40% 10.0% 3.0% $ 7,416.0 5.8% 10.87 $ 80,608.7 -21.7%

40% 15.0% 3.0% $ 7,416.0 7.8% 13.89 $ 103,000.0 0.0%
40% 20.0% 3.0% $ 7,416.0 9.8% 19.23 $ 142,615.4 38.5%

FCF0  1  i   1  I%  1.03  1  .2  $9,888

V0   $12, 000    $93, 283
r  I%  ROI  i  1  I%  .15  .2  .1  .03  1  .2  .106

©Cambridge Business Publishers, 2014

Solutions Manual, Chapter 6 6
P6.8 Growth Rates and Continuing Value – Ed Kaplan, Inc.:

a. The analyst incorrectly

(i) Used Year 3 FCF and should have used Year 4 FCF, which will be larger
because the revenue growth rate decreased. And then should have
assumed the Year 4 cash flow would grow in perpetuity.
(ii) Used Year 3 ITS and should have used Year 4 ITS, which happens to be
the same as Year 3.
(iii) Did not use a growth rate to measure the value of the interest tax shields.

b. through f. See the schedules below.

Ed Kaplan, Inc. - Income Statement and Balance Sheet Forecasts

Year -1 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Income Statement
Revenue $ 10,000.0 $ 11,000.0 $ 13,200.0 $ 15,840.0 $ 19,008.0 $ 19,578.2 $ 20,165.6
Cost of Goods Sold -2,000.0 -2,200.0 -2,640.0 -3,168.0 -3,801.6 -3,915.6 -4,033.1
Gross Margin $ 8,000.0 $ 8,800.0 $ 10,560.0 $ 12,672.0 $ 15,206.4 $ 15,662.6 $ 16,132.5
Selling, General & Administrative -1,200.0 -1,320.0 -1,584.0 -1,900.8 -2,281.0 -2,349.4 -2,419.9
Operating Income $ 6,800.0 $ 7,480.0 $ 8,976.0 $ 10,771.2 $ 12,925.4 $ 13,313.2 $ 13,712.6
Interest Expense -640.0 -800.0 -800.0 -800.0 -800.0 -800.0 -824.0
Income Before Taxes $ 6,160.0 $ 6,680.0 $ 8,176.0 $ 9,971.2 $ 12,125.4 $ 12,513.2 $ 12,888.6
Income Tax Expense -2,464.0 -2,672.0 -3,270.4 -3,988.5 -4,850.2 -5,005.3 -5,155.4
Net Income $ 3,696.0 $ 4,008.0 $ 4,905.6 $ 5,982.7 $ 7,275.3 $ 7,507.9 $ 7,733.2

Balance Sheet
Cash Balance $ 250.0 $ 275.0 $ 330.0 $ 396.0 $ 475.2 $ 489.5 $ 504.1
Accounts Receivable 1,666.7 1,833.3 2,200.0 2,640.0 3,168.0 3,263.0 3,360.9
Inventory 388.9 427.8 513.3 616.0 739.2 761.4 784.2
Total Current Assets $ 2,305.6 $ 2,536.1 $ 3,043.3 $ 3,652.0 $ 4,382.4 $ 4,513.9 $ 4,649.3
Land 20,000.0 22,000.0 26,400.0 31,680.0 38,016.0 39,156.5 40,331.2
Total Assets $ 22,305.6 $ 24,536.1 $ 29,443.3 $ 35,332.0 $ 42,398.4 $ 43,670.4 $ 44,980.5

Accounts Payable $ 166.7 $ 183.3 $ 220.0 $ 264.0 $ 316.8 $ 326.3 $ 336.1

Other Current Operating Liabilities 350.0 385.0 462.0 554.4 665.3 685.2 705.8
Total Current Liabilities 516.7 568.3 682.0 818.4 982.1 1,011.5 1,041.9
Debt 10,000.0 10,000.0 10,000.0 10,000.0 10,000.0 10,300.0 10,609.0
Total Liabilities $ 10,516.7 $ 10,568.3 $ 10,682.0 $ 10,818.4 $ 10,982.1 $ 11,311.5 $ 11,650.9
Common Stock $10,419.3 $10,419.3 $10,419.3 $10,419.3 $10,419.3 $10,419.3 $10,419.3
Retained Earnings 1,369.6 3,548.5 8,342.0 14,094.3 20,997.0 21,939.5 22,910.3
Total Shareholders Equity $ 11,788.9 $ 13,967.8 $ 18,761.3 $ 24,513.6 $ 31,416.3 $ 32,358.8 $ 33,329.6
Total Liabilities and Equities $ 22,305.6 $ 24,536.1 $ 29,443.3 $ 35,332.0 $ 42,398.4 $ 43,670.4 $ 44,980.5

©Cambridge Business Publishers, 2014

7 Corporate Valuation: Theory, Evidence & Practice, 1st Edition
 Ed Kaplan, Inc. - Free Cash Flow Forecasts
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Earnings Before Interest and Taxes (EBIT) $ 7,480.0 $ 8,976.0 $ 10,771.2 $ 12,925.4 $ 13,313.2 $ 13,712.6
- Income Taxes Paid on EBIT -2,992.0 -3,590.4 -4,308.5 -5,170.2 -5,325.3 -5,485.0
Earnings Before Interest and After Taxes $ 4,488.0 $ 5,385.6 $ 6,462.7 $ 7,755.3 $ 7,987.9 $ 8,227.6
- Change in Accounts Receivable -166.7 -366.7 -440.0 -528.0 -95.0 -97.9
- Change in Inventory -38.9 -85.6 -102.7 -123.2 -22.2 -22.8
+ Change in Accounts Payable 16.7 36.7 44.0 52.8 9.5 9.8
+ Change in Current Other Liabilities 35.0 77.0 92.4 110.9 20.0 20.6
- Change in Required Cash Balance -25.0 -55.0 -66.0 -79.2 -14.3 -14.7
Unlevered Cash Flow from Operations $ 4,309.1 $ 4,992.0 $ 5,990.5 $ 7,188.5 $ 7,885.9 $ 8,122.5
- Capital Expenditures -2,000.0 -4,400.0 -5,280.0 -6,336.0 -1,140.5 -1,174.7
Unlevered Free Cash Flow $ 2,309.1 $ 592.0 $ 710.5 $ 852.5 $ 6,745.4 $ 6,947.8
- Interest Paid -800.0 -800.0 -800.0 -800.0 -800.0 -824.0
+ Interest Tax Shield 320.0 320.0 320.0 320.0 320.0 329.6
Free Cash Flow Before Changes in Financing $1,829.1 $112.0 $230.5 $372.5 $6,265.4 $6,453.4
+ Change in Debt Financing 0.0 0.0 0.0 0.0 300.0 309.0
Free Cash Flow to Common Equity $ 1,829.1 $ 112.0 $ 230.5 $ 372.5 $ 6,565.4 $ 6,762.4

CV
Year 0 Year 1 Year 2 Year 3 Year 3

Value of the Unlevered Firm:

Unlevered Free Cash Flow for Continuing Value $
6,745
Discount Factor for Continuing Value 10.000
Unlevered Free Cash Flow and Continuing Value $ 592 $ 710 $ 853 $ 67,454
Discount Factor 0.885 0.783 0.693 0.693
Discounted Value $ 524 $ 556 $ 591 $ 46,749
Value of the Unlevered Firm $ 48,420

Value of the Interest Tax Shields:

Interest Tax Shield for Continuing Value $ 320
Discount Factor for Continuing Value 10.000
Interest Tax Shield and Continuing Value of the $ 320 $ 320 $ 320 $ 3,200
Discount Factor 0.885 0.783 0.693 0.693
Present Value $ 283 $ 251 $ 222 $ 2,218
Value of the Interest Tax Shields $ 2,973

Value of the Firm $ 51,394 $ 807 $ 807 $ 813 $ 48,967

Continuing Value $ 70,654

©Cambridge Business Publishers, 2014

Solutions Manual, Chapter 6 8
 Ed Kaplan, Inc. - Income Statement and Balance Sheet Forecasts
Year -1 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Revenue 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%

Cost of Goods Sold 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Gross Margin 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Selling, General & Administrative 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Operating Income 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Interest Expense 25.0% 0.0% 0.0% 0.0% 0.0% 3.0%
Income Before Taxes 8.4% 22.4% 22.0% 21.6% 3.2% 3.0%
Income Tax Expense 8.4% 22.4% 22.0% 21.6% 3.2% 3.0%
Net Income 8.4% 22.4% 22.0% 21.6% 3.2% 3.0%

Cash Balance 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%

Accounts Receivable 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Inventory 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Total Current Assets 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Land 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Total Assets 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%

Accounts Payable 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%

Other Current Operating Liabilities 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Total Current Liabilities 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%
Debt 0.0% 0.0% 0.0% 0.0% 3.0% 3.0%
Total Liabilities 0.5% 1.1% 1.3% 1.5% 3.0% 3.0%
Common Stock 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Retained Earnings 159.1% 135.1% 69.0% 49.0% 4.5% 4.4%
Total Shareholders Equity 18.5% 34.3% 30.7% 28.2% 3.0% 3.0%
Total Liabilities and Equities 10.0% 20.0% 20.0% 20.0% 3.0% 3.0%

Ed Kaplan, Inc. - Free Cash Flow Forecasts

Year -1 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Earnings Before Interest and Taxes (EBIT) 20.0% 20.0% 20.0% 3.0% 3.0%
- Income Taxes Paid on EBIT 20.0% 20.0% 20.0% 3.0% 3.0%
Earnings Before Interest and After Taxes 20.0% 20.0% 20.0% 3.0% 3.0%
- Change in Accounts Receivable 120.0% 20.0% 20.0% -82.0% 3.0%
- Change in Inventory 120.0% 20.0% 20.0% -82.0% 3.0%
+ Change in Accounts Payable 120.0% 20.0% 20.0% -82.0% 3.0%
+ Change in Current Other Liabilities 120.0% 20.0% 20.0% -82.0% 3.0%
- Change in Required Cash Balance 120.0% 20.0% 20.0% -82.0% 3.0%
Cash Flow Before Capital Expenditures 15.8% 20.0% 20.0% 9.7% 3.0%
- Capital Expenditures 120.0% 20.0% 20.0% -82.0% 3.0%
Unlevered Free Cash Flow -74.4% 20.0% 20.0% 691.2% 3.0%
- Interest Paid 0.0% 0.0% 0.0% 0.0% 3.0%
+ Interest Tax Shield 0.0% 0.0% 0.0% 0.0% 3.0%
Free Cash Flow Before Changes in Financing -93.9% 105.7% 61.7% 1581.8% 3.0%
+ Change in Debt Financing 3.0%
Free Cash Flow to Common Equity -93.9% 105.7% 61.7% 1662.3% 3.0%
   
D

P S
rE rUA + rUA rD × + r  r  × (3.12)
E
UA P S
E

©Cambridge Business Publishers, 2014

9 Corporate Valuation: Theory, Evidence & Practice, 1st Edition
 Below appears the year-by-year APV valuation, annual discount rates, then WACC and E-DCF:

CV
Year 0 Year 1 Year 2 Year 3 Year 3

Value of Unlevered Firm:

Unlevered Free Cash Flow for Continuing Value $ 6,745
Discount Factor for Continuing Value 10.000
Unlevered Free Cash Flow $ 592 $ 710 $ 853
Value of the Unlevered Firm at Year End $ 54,123 $ 60,449 $ 67,454
Unlevered Value at Year End Plus Unlevered Free $ 54,715 $ 61,159 $ 68,307
Discount Factor for one Year 0.885 0.885 0.885
Value of Unlevered Firm at Beginning of Year $ 48,420 $ 54,123 $ 60,449 $ 67,454

Value of the Interest Tax Shields:

Interest Tax Shield for Continuing Value $ 320
Discount Factor for Continuing Value 10.000
Interest Tax Shields $ 320 $ 320 $ 320
Value of the Interest Tax Shields at Year End $ 3,040 $ 3,115 $ 3,200
Value of the Interest Tax Shields at End of Year $ 3,360 $ 3,435 $ 3,520
Discount Factor for one Year 0.885 0.885 0.885
Beginning of Year ITS $ 2,973 $ 3,040 $ 3,115 $ 3,200
Beginning of Year VF $ 0 $ 51,394 $ 57,163 $ 63,564 $ 70,654

As of the End of Year Year 0 Year 1 Year 2 Year 3

Value of the Firm (VF) $ 51,394 $ 57,163 $ 63,564 $ 70,654

Value of Debt (D) $ 10,000 $ 10,000 $ 10,000 $ 10,000
Value of Equity (E) $ 41,394 $ 47,163 $ 53,564 $ 60,654

D PS
rE  rUA +  rUA  rD  × +  rUA  rPS  × Beg of Beg of Beg of Beg of
E E Year 1 Year 2 Year 3 Year 4

Unlevered Cost of Capital, rU 13.0% 13.0% 13.0% 13.0%

Cost of Debt, rD 8.0% 8.0% 8.0% 8.0%

Debt to Common Equity 0.2416 0.2120 0.1867 0.1649
Equity Cost of Capital, rE 14.21% 14.06% 13.93% 13.82%

CVEquity
Discounted Equity Flow Valuation Year 0 Year 1 Year 2 Year 3 Year 3

Free Cash Flow to Common Equity for Continuing $ 6,565

Discount Factor for Continuing Value 9.238
Common Equity Free Cash Flow and Common $ 112 $ 230 $ 373 $ 60,654
Equity Cost of Capital Discount Factor 0.876 0.768 0.674 0.674
Present Value $ 98 $ 177 $ 251 $ 40,868
Common Equity Value $ 41,394

©Cambridge Business Publishers, 2014

Solutions Manual, Chapter 6 10