Question

You are considering the purchase of a business that produces net cash flows of $350,000 per year in perpetuity. In a perfectly competitive market, what should be the asking price for the business if the firm’s cost of capital is 15%? (Show your work. Label $. No decimal places required. Highlight or bold your answer.)

Answer 1

Enterprise value = $2,333,333.33

Step-by-step explanation:

This is an example of perpetuity cashflow problem. Ler formulate the all the number in this exercise as below:

Enterprise value = Net cashflow_1/(1 + Cost of capital) + Net cashflow_2/(1 + Cost of capital)^2 + Net cashflow_n/(1 + Cost of capital)^n

When n approach infinity and net cashflow in every year is the same, the reduced form of above formula is:

Enterprise value = Net cashflow/Cost of capital

Putting all the number together, we have:

Enterprise value = 350,000/15% = 2,333,333.33 (this shoube be the asking price for the business).