Question

Please, write a 3-5 paragraph essay. In your own words, address the topic below. Use any outside sources you consider relevant.

An investment is worth the present value of its future cash flows. Since a company is a series of investments, it is worth the total present value of all cash flows generated by the firm.

Answer 1

the value of the firm would be the present value of all the cash flows expected in future

For example if we consider a firm that as cash flows of $1000 in year 1 , $ 2000 in year 2 and $ 3000 in year 3, then we can say that the worth of the firm is :

Worth = 1000/1.10 + 2000/1.10^2 + 3000/1.10^3 assuming a 105 discount rate

Worth = $4815.93

But in reality, firms are a going concern which means they have perpetual life and grow at a certain rate.

Now, for example, if we consider a firm that generates a profit of $1000 expected to grow at 5% for perpetuity and the discount rate is 10%, the worth of the firm is calculated as the present value of a growing perpetuity shown as:

Worth = Current profit*(1+g)/ (r - g)

Worth = 1000*(1+0.05)/(0.10-0.05)

Worth = 1000*1.05/0.05

Worth = $21,000

This is approach in which we value a firm.

Note: We have given you a synopsis and you can expand on this. we cannot five paragraphs in the given time