Question

You are trying to assess the value of a small retail store that is up for sale. The

store generated a cash flow to its owner of $ 100,000 in the most year of
operation, and is expected to have growth of about 5% a year in perpetutity.
a) If the rate of return required on this store is 10%, what would your
assessment be of the value of the store?
b) What would the growth rate need to be to justify a price of $ 2.5 million for this
store?

Answer 1

Answer: A.) 2,100,000 B.) 0.05769 or 5.77%

Explanation:1) If the rate of return required on this store is 10%, Calculation of the value of the store:

Value of Store = 100,000 {(1 + g) / 0.10 - g)}

100,000 {(1 + 0.05) / (0.10 - 0.05)}

= 100,000 * {1.05 / 0.05}

= 100,000 * 21

= 2,100,000

b) Calculation of growth rate need to be to justify a price of 2.5 million for this store:

Value of Store = 2,500,000

\Rightarrow 100,000 {(1 + g) / 0.10 - g)} = 2,500,000

\Rightarrow {(1 + g) / 0.10 - g)} = 25

\Rightarrow (1 + g) = 2.5 - 25g

\Rightarrow 26g = 1.5

g = 1.5/ 26

g = 0.05769 or 5.77%