Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows for this division for the next five? years, and have estimated that the cost of capital is 12%. You would like to estimate a continuation value. You have made the following forecasts for the last year of your? five-year forecasting horizon? (in millions of? dollars):
Year 5
Revenues $184.4
Operating income 51.1
Net income 33.2
Free cash flows 92.8
Book value of equity 272.3
?Note: Assume that all firms? (including yours) have no debt.
a. You forecast that future free cash flows after year 5 will grow at 3 % per? year, forever. Estimate the continuation value in year? 5, using the perpetuity with growth formula.
b. You have identified several firms in the same industry as your operating division. The average? P/E ratio for these firms is 27
Estimate the continuation value assuming the? P/E ratio for your division in year 5 will be the same as the average? P/E ratio for the comparable firms today.
c. The average? market/book ratio for the comparable firms is 2.4 Estimate the continuation value using the? market/book ratio.