# The horizon value is therefore \$42 million [\$2.1 million ÷ (.10 – .05

```EXAMPLE:
Company X has the following estimated earnings and investments (in millions):
Year
Earnings
Investments
1
\$10
8
2
\$12
10
3
\$15
12
4
\$16
14
5
\$16.80
14.70
Company X expects a 5% constant growth from year 5 and beyond. If the market
capitalization rate is 10%, what is the value of the business expressed as the present value
of free cash flows?
First, calculate the free cash flows for each period given:
Free cash flows = Earnings – Investments
Year
Free Cfs
1
\$2
2
\$2
3
\$3
4
\$2
5
\$2.1
Second, determine the horizon value. Because the growth rate will be 5% from year 5
and beyond, the horizon value will be calculated as follows:
(Free cash flows for year 5) &divide; ( rate of return – growth rate) = Horizon value
The horizon value is therefore \$42 million [\$2.1 million &divide; (.10 – .05)]. This amount
will be added to the year 5 cash flows and discounted at the 5-period present value
factor.
Third, calculate the discounted cash flows (in millions):
Year
1
2
3
4
5
Cash Flows
\$2
\$2
\$3
\$2
\$44.1
PV factor
0.909
0.826
0.751
0.683
0.621
Total
Example J
Discounted CF
\$1.818
\$1.652
\$2.253
\$1.366
\$27.386
\$34,475
```