Question

The head of the accounting department at a major software manufacturer has asked you to put together a pro forma statement of the company's value under several possible growth scenarios and the assumption that the company’s many divisions will remain a single entity forever. The manager is concerned that, despite the fact that the firm’s competitors are comparatively small, collectively their annual revenue growth has exceeded 50 percent over each of the last five years. She has requested that the value projections be based on the firm’s current profits of $3.7 billion (which have yet to be paid out to stockholders) and the average interest rate over the past 20 years (7 percent) in each of the following profit growth scenarios:

Instructions: Enter your responses rounded to two decimal places.

b. Profits grow at an annual rate of 4 percent.


c. Profits grow at an annual rate of 0 percent.


d. Profits decline at an annual rate of 4 percent.

Answer 1

Solution :-

(B)

Projection of Firms Current Profit (A) = $3.7 Billions

Growth Rate (g) = 4%

Interest Rate (i) = 7%

Present Value = A ( 1 + i ) / ( i - g )

= $3.7 ( 1 + 0.07 ) / ( 0.07 - 0.04 )

= $131.967 Billions

(C)

Projection of Firms Current Profit (A) = $3.7 Billions

Growth Rate (g) = 0%

Interest Rate (i) = 7%

Present Value = A ( 1 + i ) / ( i - g )

= $3.7 ( 1 + 0.07 ) / ( 0.07 - 0.00 )

= $56.56 Billions

(D)

Projection of Firms Current Profit (A) = $3.7 Billions

Growth Rate (g) = - 4%

Interest Rate (i) = 7%

Present Value = A ( 1 + i ) / ( i - g )

= $3.7 ( 1 + 0.07 ) / ( 0.07 - [ - 0.04 ] )

= $3.7 * ( 1 + 0.07 ) / 0.11

= $35.99 Billions

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