Reference no: EM133121534

(a) Consider the calculation of the continuation value (CV). Suppose FCFT+1 is $225 million regardless of the expected permanent growth rate of free cash flows. The WACC is 9%. How large is the increase in the continuation value if the expected permanent growth rate of free cash flows is increased from 1% to 3%?

(b) Consider the value driver formula. Assume that NoplatT+1 is $250 million, the WACC is 9%, and the expected permanent return on invested capital for new projects is 10%. How large is the increase in the continuation value if the expected permanent growth rate of Noplat is increased from 1% to 3%?

(c) Explain why the increase in the continuation value generated by an increase in the expected permanent growth rate from 1% to 3% is higher or lower in (a) than in (b). What is the economic intuition for your result? Explain

(d) It has been argued that forecasting free cash flows explicitly for more than ten years is typically not optimal, since one lacks precise enough information to make good forecasts after ten years. Hence, one obtains a more accurate valuation by applying the continuation value formula at the latest after ten years rather than, for example, after 20 years. Do you agree with this statement and its reasoning? Why or why not?