Question

A firm's current profits are $1,300,000. These profits are expected to grow indefinitely at a constant annual rate of 3 percent. If the firm's opportunity cost of funds is 6 percent, determine the value of the firm:

a. The instant before it pays out current profits as dividends.
b. The instant after it pays out current profits as dividends

Answer 1

a. Value of the firm = $45.93 million

b. Value of firm = $44.63 million

Step-by-step explanation:

a. Below is the calculation for the value of firm.

Value of firm = Profit [( 1 + i) / (i - g)]

Profit = 1300000

i = 6%

g = 3%

Value of the firm = 1300000 [(1 + 0.06) / (0.06 - 0.03)]

Value of the firm = $45.93 million

B. Value of the firm after it pays profit as dividend.

Value of firm = Profit [( 1 + g) / (i - g)]

Value of firm = 1300000 [(1 + 0.03) / (0.06 -0.03]

Value of firm = $44.63 million