Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows for this division for the next five years, and have estimated that the cost of capital is 10%. 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): Year 5 Revenues $292.4 Operating income 94.5 Net income Free cash flows 61.4 92.1 215.7 Book value of equity a. You forecast that future free cash flows after year 5 will grow at 4% 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 21. 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 5.9. Estimate the continuation value using the market/book ratio. Note: Assume that all firms (including yours) have no debt. a. You forecast that future free cash flows after year 5 will grow at 4% per year, forever. Estimate the continuation value in year 5, using the perpetuity with growth formula. The continuation value in year 5 is $ million. (Round to one decimal place.) b. You have identified several firms in the same industry as your operating division. The average P/E ratio for these firms is 21. 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. The continuation value in year 5 is $ million. (Round to one decimal place.) c. The average market/book ratio for the comparable firms is 5.9. Estimate the continuation value using the market/book ratio. The continuation value in year 5 is $ million. (Round to one decimal place.)
Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows for this division for the next five years, and have estimated that the cost of capital is 10%. 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): Year 5 Revenues $292.4 Operating income 94.5 Net income Free cash flows 61.4 92.1 215.7 Book value of equity a. You forecast that future free cash flows after year 5 will grow at 4% 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 21. 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 5.9. Estimate the continuation value using the market/book ratio. Note: Assume that all firms (including yours) have no debt. a. You forecast that future free cash flows after year 5 will grow at 4% per year, forever. Estimate the continuation value in year 5, using the perpetuity with growth formula. The continuation value in year 5 is $ million. (Round to one decimal place.) b. You have identified several firms in the same industry as your operating division. The average P/E ratio for these firms is 21. 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. The continuation value in year 5 is $ million. (Round to one decimal place.) c. The average market/book ratio for the comparable firms is 5.9. Estimate the continuation value using the market/book ratio. The continuation value in year 5 is $ million. (Round to one decimal place.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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![### Valuation of a Proposed New Operating Division
**Overview:**
Your firm aims to evaluate a proposed new operating division. The firm has forecasted cash flows for this division over the next five years and estimated the cost of capital at 10%. As part of this evaluation, the firm needs to estimate a continuation value for the division. Below is the financial data provided for the last year of the five-year forecasting horizon (in millions of dollars):
#### Year 5 Financial Data:
- **Revenues:** $292.4
- **Operating income:** $94.5
- **Net income:** $61.4
- **Free cash flows:** $92.1
- **Book value of equity:** $215.7
**Tasks:**
A series of questions guide the estimate of the continuation value using different methods.
### Task A:
**Estimating Continuation Value Using the Perpetuity with Growth Formula**
**Question A:**
Forecast the future free cash flows after Year 5 will grow at 4% per year, forever. Estimate the continuation value in Year 5 using the perpetuity with growth formula.
Formula:
\[ \text{Continuation Value} = \frac{\text{Free Cash Flows in Year 5} \times (1 + \text{Growth Rate})}{\text{Cost of Capital} - \text{Growth Rate}} \]
(Note: Enter the continuation value rounded to one decimal place.)
\[ \text{The continuation value in year 5 is \$ } \_\_\_\_\_\_ \text{ million.} \]
### Task B:
**Estimating Continuation Value Using the P/E Ratio**
**Question B:**
Identify several firms in the same industry as your operating division. The average P/E ratio for these firms is 21. 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 comparable firms today.
Formula:
\[ \text{Continuation Value} = \text{Net Income in Year 5} \times \text{P/E Ratio} \]
(Note: Enter the continuation value rounded to one decimal place.)
\[ \text{The continuation value in year 5 is \$ } \_\_\_\_\_\_ \text{ million.} \]
### Task C:
**Estimating Continuation Value Using the Market/Book Ratio**
**Question C:**
The average market/book ratio for](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fb7986b84-3c9d-489d-9437-e65030bcb5d0%2Fc889b200-c476-43b3-8527-1cde125f4c19%2Frkk8qt_processed.png&w=3840&q=75)
Transcribed Image Text:### Valuation of a Proposed New Operating Division
**Overview:**
Your firm aims to evaluate a proposed new operating division. The firm has forecasted cash flows for this division over the next five years and estimated the cost of capital at 10%. As part of this evaluation, the firm needs to estimate a continuation value for the division. Below is the financial data provided for the last year of the five-year forecasting horizon (in millions of dollars):
#### Year 5 Financial Data:
- **Revenues:** $292.4
- **Operating income:** $94.5
- **Net income:** $61.4
- **Free cash flows:** $92.1
- **Book value of equity:** $215.7
**Tasks:**
A series of questions guide the estimate of the continuation value using different methods.
### Task A:
**Estimating Continuation Value Using the Perpetuity with Growth Formula**
**Question A:**
Forecast the future free cash flows after Year 5 will grow at 4% per year, forever. Estimate the continuation value in Year 5 using the perpetuity with growth formula.
Formula:
\[ \text{Continuation Value} = \frac{\text{Free Cash Flows in Year 5} \times (1 + \text{Growth Rate})}{\text{Cost of Capital} - \text{Growth Rate}} \]
(Note: Enter the continuation value rounded to one decimal place.)
\[ \text{The continuation value in year 5 is \$ } \_\_\_\_\_\_ \text{ million.} \]
### Task B:
**Estimating Continuation Value Using the P/E Ratio**
**Question B:**
Identify several firms in the same industry as your operating division. The average P/E ratio for these firms is 21. 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 comparable firms today.
Formula:
\[ \text{Continuation Value} = \text{Net Income in Year 5} \times \text{P/E Ratio} \]
(Note: Enter the continuation value rounded to one decimal place.)
\[ \text{The continuation value in year 5 is \$ } \_\_\_\_\_\_ \text{ million.} \]
### Task C:
**Estimating Continuation Value Using the Market/Book Ratio**
**Question C:**
The average market/book ratio for
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