Free cash flow valuation Lin is evaluating the potential purchase of a small business with no debt or preferred stock that is currently generating £32,000 of free cash flow 1FCF0 = +32,0002 every year. On the basis of a review of similar-risk investment opportunities, Lin must earn an 18% rate of return on the proposed purchase. Because she is relatively uncertain about future cash flows, Lin has decided to estimate the firm’s value using several possible assumptions about the growth rate of cash flows.

a. What is the firm’s value if cash flows are expected to grow at an annual rate of 0% (or remain constant at the current level) from now to infinity?

b. What is the firm’s value if cash flows are expected to grow at an annual rate of 8% from now to infinity?

c. What is the firm’s value if cash flows are expected to grow at an annual rate of 10% for the first two years, followed by a constant annual rate of 8% from year 3 to infinity?