Anybody there for tonights ‘Lock and Key party’ and wants to help me find the key to this mental lock? Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27 percent inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20 percent in the second year and 10 percent in the third year, where he expects inflation to stabilize. Johnson predicts that by year 3, Wavington will have nominal free cash flow of $187 million growing at 4 percent annually in real terms. In view of his optimistic outlook, he is considering an investment in Wavington, and has calculated the real WACC for Wavington at 8 percent. The nominal continuing value of Wavington in year 3 is closest to: A) $4,250. B) $4,675. C) $4,862. D) $5,348.
just a wild assed guess: D? . scale up nominal growth rate to 14.4 %, nominal wacc-nominal growh is still 4%. nominal cash flow next year is 213.92 million. i am sure i am wrong.
Dsylexic - wanna give it another shot?
ok C then -same logic, just using the exact relationship between real rates and nominal rates .so denominator = 18.8 -14.4 = 4.4 %. nominal cash is still 213.92 hope i am going somewhere with this.
FCF_4 = 187*1.04*1.1=213.93 WACC_nominal = 1.1*1.08-1 = 18.8% g_nominal = 1.1*1.04-1 = 14.4% ContVal_3 = FCF_4/(WACC-g) = 213.93/4.4% = $4862
Bingo!! The correct ans is C. Neat work chris!
note to self: always err on the side of exact calculations