Following is a free cash flow forecast for Egon’s Paranormal Investigations Corporation. Use this information for problems following.

($ millions)                 2002            2003       2004      2005

NOPAT                        20.0              22.0        25.0       28.0

Free cash flow          (2.0)               15.0        10.0       20.0

1. You expect NOPAT to grow at 3% per year and for free cash flow to be equal to NOPAT, beginning in 2006. The book value of Egon’s core operations at December 31, 2001, is $100 million and its weighted-average cost of capital is 9%.

a.Forecast Egon’s book value of core operations for 2002–2006.
b.Forecast Egon’s residual income for 2002–2006.
c.Calculate the value of Egon’s core operations as of December 31, 2001, using the residual income method.

2. Confirm your answer to problem 1(c) by taking the present value of Egon’s forecasted free cash flows.3. Redo problem 1 assuming the book value of Egon’s core operations at December 31, 2001, is only $80 million.