Jones Group Inc. is the parent company of Midwest Pipeline Inc., a mature, stable natural gas transmission pipeline company in the United States. In 1998, Jones Group established DCom Crop., a 100 percent owned subsidiary whose mandate is to install and commercialize a long-haul data communications network.

Tom Anderson, Chief Executive Officer of DCom, hires Vala and Associates to provide additional insight into capital markets and corporate finance issues. During the initial meeting in December 2000 with Jim Vala, CFA, Anderson comments:

I do not believe the full value of DCom is reflected in the market price of Jones Group equity. I think DComs full value can be determined using the free cash flows to the firm model.

Vala has the following notes from his initial meeting with Anderson.

The data communications network was built on existing property alongside Midwest Pipelines transmission pipelines.

The major network construction is nearing completion and DComs sales force is now in place.

Network data traffic is expected to grow at a rate of 50 percent annually through 2003 and 15 percent annually thereafter.

Beginning in 2004, DComs free cash flows to the firm are expected to grow at a sustainable rate of 12 percent annually.

The weighted average cost of capital for DCom is 15 percent.

The appropriate tax rate for DCom is 40 percent.

A) Calculate the total firm value of DCom at the end of year 2000, using the free cash flows to the firm (FCFF) model.

B) State whether total firm value as determined by the FCFF model is appropriate to assess the value that DCom should contribute to the market price of Jones Group equity.

Support your response with one reason.

Exhibit 1-3 Dcom Corp. Summary Income Statement and Balance Sheet (U.S. ons, except per share data) December, 31 2000 2001 2002 2003 Summary Income Statement (for the year) Actual Projection Projection Projection 70.00 105.00 157.50 236.25 Total Revenue 15.23 s 22.84 34.26 s 51.39 Total operating Expenses Earnings Before Interest, Taxes, 54.78 82.16 123.25 184.87 epreciation & Amortization (EBITDA) 69.00 s 129.00 136 so s 144.00 Depreciation and Amortization (14.23) S (46.84) s (13.26) S 40.87 Earnings Before Interest & Taxes (EBIT) 66.15 118.80 131.63 131.63 Interest Expense (80.38) (165.64) (144.88) (90.76) S 22.071 s (44.66) S (40.58 s 29.48 Income Tax Expense 2000 2001 2002 2003 Summary Balance Sheet (year end) Actual Projection Projection Projection 222.07 s 253.7 113.12 130.93 Total Current Assets S 391.00 s 662.00 S 575.50 S 481.50 Net Fixed Assets $504.12 792.93 797.57 735.25 Total Assets 5.60 863 12.95 S 19.42 Total Current Liabilities S190.00 s 880.00 s 975.00 s 975.00 Long-term Debt $495.60 S 888.63 987.95 994.42 Total Liabilities common stock 60.00 s 60.00 60.00 60.00 S51.49) s 15570 S 250.38 S 391) Retained Earnings 8.51 (95.70) S (190.38) S (259.17) Total Shareholder's Equity Total Liabilities and Equity 504.11 792.93 797.57 s 735.25 Dividends S 75.00 300.00 75.00 Capital Expenditures is 10.38 (8.64) 12.94) Changes in Working Capital excluding cash and short-term debt