Question

You own a store that is expected to make annual cash flows forever. The cost of capital for the store is 17.89 percent. The next annual cash flow is expected in one year from today and all subsequent cash flows are expected to grow annually by 5.76 percent. What is the value of the store if you know that the cash flow in 5 years from today is expected to be 10,500?

Answer 1

Sol:

Cost of capital (r) = 17.89%

Annual growth rate (g) = 5.76%

Expected cash flow (C) = $10,500

Period = 4 years

To determine value of the store:

The cash flow valuation is used to value a firm by discounting all the future cash flows to the present value. The value of the firm would be the value of all the future cash flows.

Cash flow are expected to start after one year, therefore we have to calculate the cash flow after a year:

CF1 = C / ((1 + g)^4

CF1 = $10,500/ ((1 + 5.76%)^4

CF1 = $10,500 / 1.0576^4

CF1 = $8,392.74

Value of the store = CF1 /(r - g)

Value of the store = 8,392.74 (17.89% - 5.76%)

Value of the store = 8,392.74 (0.1789 - 0.0576)

Value of the store = 8,392.74 / 0.1213

Value of the store = $69,189.94