Question

2. Your company manufactures widgets. The fixed cost incurred (independent of the number of widgets produced)...

2. Your company manufactures widgets. The fixed cost incurred (independent of the number of widgets produced) each year is $80,000. The variable cost per widget is $0.25. The sale price of each widget is $1.00. The price and the costs are expected to remain unchanged over time. In year 1, the company expects to sell 100,000 widgets. It expects its sales to increase at the rate of 4% a year forever. The discount rate is 10%. Ignore taxes. What is the value of this company?

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Answer #1

Solution:

Calculation of vaalue of the company

In the given case,contribution will increase by 4% per year while the fixed cost will remain constant.We know that,value of the company is;

=Expected EBIT/(Discount rate-Growth rate)

Thus,we have to calculate the present value of contribution and fixed cost to arrive at the value of the company as follow:

Value of company=[Contribution/(Discount rate-growth rate)]-[Fixed cost/discount rate]

=[(($1-0.25)*100,000)/10%-4%]-[$80,000/10%]

=$1250,000-$800,000

=$450,000

Thus value of company is $450,000.

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