Question

Founders of a firm put up 140 million at time 1 to be withdrawn completely at time 2 by selling the firm to new stockholders. The 140 million investment will generate the following cash earnings: 55 million, 72.60 million and 93.17 million at times 2,3 and 4 respectively. The market interest rate is 10% in all periods. What are the market values of the firm in every period?

Answer 1

To determine the market values of the firm in each period, calculate the present value of the cash earnings at the market interest rate of 10%.

Step-by-step explanation:

To determine the market values of the firm in each period, we need to calculate the present value of the cash earnings at the market interest rate of 10%. Present value is calculated using the formula: PV = CF / (1+r)^n, where PV is the present value, CF is the cash flow, r is the interest rate, and n is the number of periods.For time 2, the cash earnings of $55 million has a present value of approximately $50 million ($55 million / (1+0.10)^1).For time 3, the cash earnings of $72.60 million has a present value of approximately $60.50 million ($72.60 million / (1+0.10)^2).For time 4, the cash earnings of $93.17 million has a present value of approximately $72.94 million ($93.17 million / (1+0.10)^3).Therefore, the market values of the firm at times 2, 3, and 4 are approximately $50 million, $60.50 million, and $72.94 million, respectively.