You are evaluating the potential purchase of a small business currently generating $ 42,500 of after-tax cashflow. On the basis of a review of similar risk investment opportunities, you must earn 15% rate of return on the proposed purchase. Because you are relatively uncertain about future cash flows, you decide to estimate the firm’s value using several assumptions about the growth rate of cash flows. What is the firm’s value if cash flows are expected to grow at an annual rate 12% for the first 2 years, followed by a constant rate of 9% from year 3 to infinity?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
You are evaluating the potential purchase of a small business currently generating $ 42,500 of after-tax cashflow. On the basis of a review of similar risk investment opportunities, you must earn 15%
What is the firm’s value if cash flows are expected to grow at an annual rate 12% for the first 2 years, followed by a constant rate of 9% from year 3 to infinity?
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