Complete Question:
Your firm currently has net working capital of $132,000 that it expects to grow at a rate of 4% per year forever. You are considering some suggestions that could slow that growth to 2% per year. If your discount rate is 10%, how would these changes impact the value of your firm? The value of the firm would $ (Round to the nearest dollar.)
Answer:
The Firm
a. The changes will reduce the value of the firm from $2,200,000 to $1,650,000, a difference of $550,000.
b. The value of the firm would be $1,650,000 if the changes are retained.
Step-by-step explanation:
a) Data and Calculations:
Current net working capital = $132,000
Expected growth rate = 4%
Desired growth rate = 2%
Firm's discount rate = 10%
Value of firm with expected growth rate of 4% = NWC/(k - g)
where NWC = Net Working Capital
k = discount rate
g = growth rate
Therefore value of the firm = $132,000/(0.1 - 0.04)
= $132,000/0.06
= $2,200,000
Value of the firm with reduced growth rate of 2%:
= $132,000/(0.1 - 0.02)
= $132,000/0.08
= $1,650,000