Question

A company has annual net operating cash flow (X) of 1.4 million dollars in perpetuity and...

A company has annual net operating cash flow (X) of 1.4 million dollars in perpetuity and the market value of its capital (V) is 11.5 million dollars. What is the company's cost of capital k o? Provide your answer as a percentage to two decimal places.

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Answer #1

We can use perpetuity method which pays equal amount of payment with periodic interval for indefinite time.

Formula for calculation of Present value of perpetuity is

Present Value of a perpetuity or the market value of its capital (V) = annual net operating cash flow (X) / company's cost of capital k

Where,

Present Value of a perpetuity or the market value of its capital (V) = $11.5 million

Annual net operating cash flow (X) = $1.4 million

Company’s cost of capital k =?

Therefore,

$11.5 million = $1.4 million/k

Or k = $1.4 million/ $11.5 million = 0.1217 or 12.17%

Therefore the company's cost of capital k is 12.17%

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