Your company manufactures widgets. The fixed cost incurred (independent of the number of widgets produced) each...

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?

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Expert Solution

Sales and variable costs are linked. So it will increase at 4%. But fixed costs remains same. So separate present values of contribution and fixed costs shall be calculated. Difference of contribution present values over fixed cost present value will be present. value of firm

.
Sales(100000*1)=   100000
less : variable costs(0.25*100000)   -25000
Contribution    75000


So growth rate=   4%
Discount rate=   10%

Present value of contribution = Contribution/(Discount rate - growth rate)
75000/(0.10-0.04)= $1250000

Fixed costs =    $80,000
Present value of fixed costs = 80000/(0.10-0)=   $800,000

Value of this company = PV of contribution - PV of fixed costs
1250000 -$800,000
$450,000

So value of this company is $450000

jeff jeffy answered 1 year ago

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