Gonzales Corporation generated free cash flow of $ 85 million this year. For the next two years, the company's free cash flow is expected to grow at a rate of 8%. After that time, the company's free cash flow is expected to level off to the industry long-term growth rate of 4% per year. If the weighted average cost of capital is 10% and Gonzales Corporation has cash of $100 million, debt of $300 million, and 100 million shares outstanding, what is Gonzales Corporation's expected free cash flow in year 2?

Free cash flow in year 2 is $ 99.14   million

Explanation:

Year one free cash flow=free cash flow in the current year*(1+growth rate)

free cash flow in  the current year is $85 million

free cash flow growth rate is 8%

year one free cash flow=$85 million*(1+8%)

                                       =$85 million *1.08=91.8  million

year two free cash flow=year one free cash flow*(1+growth rate)

year one free cash flow $91.8  million

free cash flow growth rate remains at 8%

year two free cash flow=$91.8  million *(1+8%)=$91.8 million  *1.08=$99.14  million

The free cash flow in year for Gonzales corporation is computed as $ 99.14  million

Alternatively

free cash flow in year two=$85 million *(1+8%)^2 =$ 99.14   million

88 because 4 plus 4 equals 8. 40 plus 40 equals 80. 80 plus 8 equals 88

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