Consider a firm with year 0 free cash flows (FCF) of $200 million. Assume that these free cash flows are a growing perpetuity, growing at a constant growth rate of 3% per year, forever. Assume that year 0 ended yesterday, and the year 1 free cash flow is exactly one year away. Other information for the firm is as follows: Cost of Debt, RD = 11%; Cost of Equity, RE = 20%; Tax Rate = 35%; and the firm uses 25% debt and 75% equity in its capital structure.
a. What is the appropriate discount rate at which the free cash flows of the firm should be discounted to compute this firm’s value?
b. What is the value of the firm?