Question

Your company manufactures widgets. The fixed cost incurred (independent of the number of widgets produced) each year is $80,000. The variable cost per widget is $0.25. The sale price of each widget is $1.00. The price and the costs are expected to remain unchanged over time. In year 1, the company expects to sell 100,000 widgets. It expects its sales to increase at the rate of 4% a year forever. The discount rate is 10%. Ignore taxes. What is the value of this company

Answer 1

$450,000

Step-by-step explanation:

Since the cash flows from the first 2 years are negative, we cannot calculate a negative terminal value. But we can calculate the present value of the total contribution margin and the fixed costs separately and the find the difference between them.

contribution margin = $100,000 - $25,000 = $75,000

growth rate = 4%

discount rate = 10%

the present value of contribution margin = $75,000 / (10% - 4%) = $1,250,000

now we calculate the present value of fixed costs = $80,000 / 10% = $800,000

the company's value = $1,250,000 - $800,000 = $450,000