Question

Marko inc., is considering the purchase of ABC Co. Marko believes that ABC Co. can generate cash flows of 6100, 11100, and 17300 over the next three years, respectively. After that time, they feel the business will be worthless. Marko has determined that a rate of return 15 percent is applicable to this potential purchase. What is Marko willing to pay today to buy ABC Co.

Answer 1

The amount Marko is willing to pay today to buy ABC Co is the sum of present value of all expected future cash flows discounted at required rate of return of the project

Sum of PV of future cash flows = Worth of the company

Or

Sum of [Expected cash flow/ (1+ required rate of return) ^n] = Worth of the company

Or

CF1/ (1+r) ^1 + CF2/ (1+r) ^2 + CF3/ (1+r) ^3 = Worth of the company

Where,

   r = the required rate of return = 15% or 0.15

   CF1 = the cash flow of period one = $6100

   CF2 = the cash flow of period two = $11100

   CF3 = the cash flow of period three = $ 17300

Now putting the values in the formula, we have

$6100/ (1+0.15) ^1 + $11100 / (1+0.15) ^2   + $17300 / (1+0.15) ^3 = Worth of the company

Worth of the company = $5304.35 + $8393.20 + $11375.03

= $25,072.57

Therefore Marko is willing to pay today $25,072.57 or less to buy ABC Co.