Question

Please answer part 1 and part 2 of this question please (multiple choices):

Question 1

Part 1

A firm reported after-tax operating income of $50 million in the most recent year on capital invested of $400 million. The firm expects operating income to grow 5% a year for the next three years, and 3% thereafter. If the firm's cost of capital is 10% and you expect the firm's current return on capital to continue in perpetuity. Estimate the value (in millions) at the end of the third year.

A. $509.60

B. $476.88

C. $439.23

Part 2

Based on information provided above, if you expect operating income to drop 5% a year in perpetuity after year 3, estimate the terminal value.

A. $509.60

B. $476.88

C. $439.23

D. $401.76

Answer 1

They are asking me to get the terminal value in Part 2 but technically there is no terminal point as cash flows never reduce to 0.

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