Question
In: Finance
You are running a hot Internet company. Analysts predict that its earnings will grow at 40%...
You are running a hot Internet company. Analysts predict that its earnings will grow at 40% per year for the next five years. After that, as competition increases, earnings growth is expected to slow to 3% per year and continue at that level forever. Your company has just announced earnings of $5 million. What is the present value of all future earnings if the interest rate is 7%? (Assume all cash flows occur at the end of the year.)
Solutions
Expert Solution
Present value = PV of future earnings
Earnings Calculation:
| Year | Earnings | Formula | Calculation |
| 1 | $ 7,000,000.00 | D0 ( 1 + g) | 5000000 ( 1 + 0.4 ) |
| 2 | $ 9,800,000.00 | D1 ( 1 + g) | 7000000 * ( 1 + 0.4 ) |
| 3 | $ 13,720,000.00 | D2 ( 1 + g) | 9800000 * ( 1 + 0.4 ) |
| 4 | $ 19,208,000.00 | D3 ( 1 + g) | 13720000 * ( 1 + 0.4 ) |
| 5 | $ 26,891,200.00 | D4 ( 1 + g) | 19208000 * ( 1 + 0.4 ) |
| 6 | $ 27,697,936.00 | D5 ( 1 + g) | 26891200 * ( 1 + 0.03 ) |
value of future earnings at the end of Year 5 = Earnings for Year 6 / [ Required Ret - Growth Rate ]
= $ 27697936.00 / [ 7% - 3% ]
= $ 27697936 / 4%
= $ 692,448,400
PV of Earnings Today:
| Year | Earnings | PVF@7% | PV of Earnings |
| 1 | $ 7,000,000.00 | 0.9346 | $ 6,542,056.07 |
| 2 | $ 9,800,000.00 | 0.8734 | $ 8,559,699.54 |
| 3 | $ 13,720,000.00 | 0.8163 | $ 11,199,606.87 |
| 4 | $ 19,208,000.00 | 0.7629 | $ 14,653,691.23 |
| 5 | $ 26,891,200.00 | 0.7130 | $ 19,173,053.95 |
| 5 | $ 692,448,400.00 | 0.7130 | $ 493,706,139.21 |
| PV of Earnings | $ 553,834,246.87 |
PV of earnings is $ 553,834,246.87
Pls comment, if any further assistance is required.
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