Question

You want to start your own consulting business and believe it could produce cash flows of $5,600 this year, $48,200 for the following eight years (years 2 through 9), and $125,000 ten years from now. At the end of ten years you think you can sell the business for $450,000. At a 14 percent discount rate, what is this business idea worth today?

Answer 1

Answer-

Given

Cash flows

Year # 1 -- -----------------$ 5600
Year # 2 to Year # 9 --- $ 48200
Year # 10 ------------------$ 125000

At the end of 10 years the business can be sold for $ 450000

Discount rate = 14 % = 0.14
Discount factor = ( 1+ 0.14) = 1.14 for first year and so on----

The busness worth today

NPV = $ 5600 + $ 48200 / 1.14 + $ 48200 / 1.142 + $ 48200 / 1.143 + $ 48200 / 1.144 + $ 48200 / 1.145 + $ 48200 / 1.146 + $ 48200 / 1.147 + $ 48200 / 1.148 + $ 125000 / 1.149

NPV = $ 5600 + $ 48200 / 1.14 + $ 48200 / 1.3 + $ 48200 / 1.48 + $ 48200 / 1.69 + $ 48200 / 1.925 + $ 48200 / 2.19 + $ 48200 / 2.5 + $ 48200 / 2.85 + $ 125000 / 3.25

NPV = $ 5600 + $ 42280.7 + $ 37076.92 + $ 32567.57 + $ 28520.71 + $ 25038.96 + $ 22009.13 + $ 19280 + $ 16912.28 + $ 38461.54

NPV = $ 267747.81  

NPV on selling the business for $ 450000 = $ 450000 / 1.149  = $ 450000 / 3.25 = $ 138461.54

Total NPV = $ 267747.81 + $ 138461.54 = $ 406209.35

Therefore the consulting business worth today = $ 406209.35

Note- The cash flow first year is $ 5600 and it's not year zero therefore the last cash flow of $ 125000 at 10 years from now is discounted by 1.149 instead of 1.1410 as the cash flow is disounted to year 1 not year 0. Similar is the case when the business is sold. The year of establishment and first cash flow is same ( year 1).