Judd Corporation has a weighted average cost of capital of 10.25%, and its value of operations is $57.50 million. Free cash flow is expected to grow at a constant rate of 6.00% per year. What is the expected year-end free cash flow, FCF1 in millions?
Business · High School · Thu Feb 04 2021
Answered on
To calculate the expected year-end free cash flow (FCF1) for Judd Corporation, we can use the Gordon Growth Model (also known as the Dividend Discount Model) formula, which is typically used for valuing a company with constant growth. It calculates the present value of an infinite series of future free cash flows that are expected to grow at a constant rate.
The formula of the Gordon Growth Model is:
\[ P = \frac{FCF_1} {WACC - g} \]
where: - \( P \) is the value of the operations (which is given as $57.50 million) - \( FCF_1 \) is the expected year-end free cash flow - \( WACC \) is the weighted average cost of capital (which is given as 10.25%, or 0.1025 in decimal form) - \( g \) is the growth rate of the free cash flow (which is given as 6%, or 0.06 in decimal form)
Given the above formula and the values provided, we can rearrange the formula to solve for \( FCF_1 \):
\[ FCF_1 = P \times (WACC - g) \]
Plugging in the given numbers:
\[ FCF_1 = $57.50 \text{ million} \times (0.1025 - 0.06) \]
\[ FCF_1 = $57.50 \text{ million} \times 0.0425 \]
\[ FCF_1 = $2.44375 \text{ million} \]
So, the expected year-end free cash flow (FCF1) is approximately $2.44375 million.