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Problem - The Menendez Corporation forecasts free cash flow of $100 at Year 1 and $120 at Year 2; after Year 2, the FCF is expected to grow at a constant rate of 4%. The company has a tax rate of 25% and $800 in debt at an interest rate of 5%. The company plans to hold debt steady until after Year 2, after which the debt (and tax savings) will grow at a constant rate of 4%. The unlevered cost of equity is 8%. Using the compressed APV model, answer the following questions.
Required -
a. What is the unlevered horizon value of operations at Year 2?
b. What is the current unlevered value of operations?
c. What are the tax savings for Year 1 and Year 2 (Hint: They are identical because the debt doesn't change.)
d. What is the horizon value of the tax shield at Year 2?
e. What is the current value of the tax shield?
f. What is the levered value of operations at Year 0?
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