Question

Subject: Managerial Economics Assume your firm is expected to grow at 3 percent for the foreseeable...

Subject: Managerial Economics

Assume your firm is expected to grow at 3 percent for the foreseeable future. Given that the interest rate is 5 percent, and that the firm’s current profits are $50 million,

1.1 What is the value of the firm based on its current and future earnings?

1.2 What is the value of the firm given that you have paid a dividend that is equal to the firm’s profits?

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Homework Answers

Answer #1

(1.1) In this case, valuation is based entirely on the current and future earnings.

Value ($ Million) = Current profit + {[Current profit x (1 + profit growth rate)] / (Interest rate - Profit growth rate)}

= 50 + {[50 x (1 + 0.03)] / (0.05 - 0.03)}

= 50 + [(50 x 1.03) / 0.02]

= 50 + 2,575

= 2,625

(1.1) In this case, valuation is based entirely on the future profit.

Value ($ Million) = [Current profit x (1 + profit growth rate)] / (Interest rate - Profit growth rate)

= [50 x (1 + 0.03)] / (0.05 - 0.03)

= (50 x 1.03) / 0.02

= 2,575

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