Question

Oasis Telephony has been working on a new hands-free telephone that clips into your ear. The new gadget has now been cleared for manufacture and development. Oasis Telephony anticipates the first annual cash flow from the phone to be €200,000, received 2 years from today. Subsequent annual cash flows will grow at 5 per cent in perpetuity. What is the present value of the phone if the discount rate is 10 per cent?

Answer 1

Given details:

First annual cash flow from the phone = €200,000

time period = 2 years from the present date

The subsequent growth rate of annual cash flows = 5% or 0.05(Perpetuity)

Discounted rate (r) = 10% or 0.10

So, if a company is projected to make  €200,000 in year 2, and the company’s cost of capital (r) is 10%, with a long-term growth rate of 5%, the present value of the phone under perpetuity is,

= Cash flow _{year 2} / r - g

= € 200,000 / 0.10 - 0.05

=  € 200,000 / 0.05

= € 4,000,000