Question

A firm's current profits are $650,000. These profits are expected to grow indefinitely at a constant annual rate of 5 percent. If the firm's opportunity cost of funds is 7 percent, determine the value of the firm:

Answer 1

a. Value before dividends are paid out;

= Current Profits * ( 1 + opportunity cost of funds) / ( Opportunity cost - growth rate)

= 650,000 * ( 1 + 0.07) / 0.07 - 0.05)

= $34,775,000

= $34.775 million

b. Value after dividends

= Current Profits * ( 1 + growth rate) / ( Opportunity cost - growth rate)

= 650,000 * ( 1 + 0.05) / 0.07 - 0.05)

= $34,125,000

= $34.125 million