You are evaluating the potential purchase of a small business with no debt or preferred stock that is currently generati
Posted: Thu Apr 28, 2022 1:51 pm
You are evaluating the potential purchase of a small business
with no debt or preferred stock that is currently generating
$42,500 of free cash flow (FCF0=$42,500). On the basis of a review
of similar-risk investment opportunities, you must earn an 18% 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 an annual rate of 12% for the first 2 years, followed by a
constant annual rate of 7% from year 3 to infinity?
with no debt or preferred stock that is currently generating
$42,500 of free cash flow (FCF0=$42,500). On the basis of a review
of similar-risk investment opportunities, you must earn an 18% 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 an annual rate of 12% for the first 2 years, followed by a
constant annual rate of 7% from year 3 to infinity?