Question

  You are evaluating the potential purchase of a small business with no debt or preferred stock that is currently generating ​$42 comma 700 of free cash flow ​(FCF 0​= ​$42 comma 700​). On the basis of a review of​ similar-risk investment​ opportunites, you must earn​ a(n) 19​% rate of return on the proposed purchase. Because you are relatively uncertain about future cash​ flows, you decide to estimate the​ firm's value using several possible assumptions about the growth rate of cash flows. a. What is the​ firm's value if cash flows are expected to grow at an annual rate of​ 0% from now to​ infinity? b. What is the​ firm's value if cash flows are expected to grow at a constant annual rate of 8​% from now to​ infinity? c. What is the​ firm's value if cash flows are expected to grow at an annual rate of 11​% for the first 2​ years, followed by a constant annual rate of 8​% from year 3 to​ infinity? a. The​ firm's value, if cash flows are expected to grow at an annual rate of​ 0% from now to​ infinity, is ​$ 224736.84. ​(Round to the nearest​ cent.) b. The​ firm's value, if cash flows are expected to grow at a constant annual rate of 8​% from now to​ infinity, is ​$ 419236.36. ​(Round to the nearest​ cent.) c. The​ firm's value, if cash flows are expected to grow at an annual rate of 11​% for the first 2​ years, followed by a constant annual rate of 8​% from year 3 to​ infinity, is ​$ 83905.91. ​(Round to the nearest​ cent.)

Answer 1

A. VALUE OF THE FIRM = $42700/19*100 = $224736 APPROX

B. WHEN CONSTANT GROWTH OF 8% = $42700(1.08)/(19-8)*100 = $419236 APPROX

C.WHEN GROTH IS VARIABLE = $83905.91