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Personal Finance Problem
LG 4 P7-16 Free cash flow valuation You are evaluating the potential purchase of a small
business with no debt or preferred stock that is currently generating $42,500 of
free cash flow (FCF0 = $42,500). On the basis of a review of similar-risk investment
opportunities, you must earn an 18% rate of return on the proposed purchase.
Because you are relatively uncertain about future cash flows, you decide to
estimate the firm’s value using several possible assumptions about the growth
rate of cash flows.
a. What is the firm’s value if cash flows are expected to grow at an annual rate of
0% from now to infinity?
b. What is the firm’s value if cash flows are expected to grow at a constant annual
rate of 7% from now to infinity?
c. What is the firm’s value if cash flows are expected to grow at an annual rate of
12% for the first 2 years, followed by a constant annual rate of 7% from year 3
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