Question
You are evaluating the potential purchase of a small business currently generating $42,500 of after-tax cash flow. Based on a review of similar-risk investment opportunities,
You are evaluating the potential purchase of a small business currently generating $42,500 of after-tax cash flow. Based on a review of similar-risk investment opportunities, you feel you must earn an 18 percent rate of return on the proposed purchase. Because you are relatively uncertain about future cash flows, you decide to estimate the firms value using several possible growth rate assumptions for the cash flow.
a) What is the firms value if cash flows are expected to remain at the current level from now to infinity?
b) What is the firms value if cash flows are expected to grow at a constant annual rate of 7 percent to infinity?
c) What is the firms value if cash flows are expected to grow at an annual rate of 12 percent for the first 4 years followed by a constant annual rate of 7 percent in years 5 to infinity?
d) Explain why the companys value is different in parts a, b, and c above?
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