Question

You own a wholesale plumbing supply store. The store currently generates revenues of $ 1.02 million per year. Next​ year, revenues will either decrease by 9.5 % or increase by 5.2 %​, with equal​ probability, and then stay at that level as long as you operate the store. You own the store outright. Other costs run $ 890000 per year. There are no costs to shutting​ down; in that case you can always sell the store for $ 360000. What is the business worth today if the cost of capital is fixed at 10.3 % question mark  ​(​Hint: Make sure to round all intermediate calculations to at least four decimal places.​)​

Answer 1

Current revenue = $ 1.02million

Next year revenue = $1.02mn*.905 + $1.02mn*1.052 = $1.99614mn

This is the probable revenue for next year and for as long as the store operates.

Running costs per year = $890,000

Net cash inflow for current year = $1.02mn - $890,000 = $130,000

Net cash inflow for all future years = $1.99614mn - $890,000 = $1,106,140

If we assume that we operate the store for an indefinite period than in that case the selling value of the store is not relevant and the value will be as follows :

= 130000/1.103 + 1106140/.103 = $10,857,083.6817

Here we have taken 1106140 to calculate the terminal value.

We can also assume that we run the store for a finite period say 5 years. In that case value will be as follows:

= 130000/1.103 + 1106140/(1.103)2 + 1106140/(1.103)3 + 1106140/(1.103)4 + 1106140/(1.103)5 + 360000/(1.103)5

= $3,496,723