Question

Marko, Inc., is considering the purchase of ABC Co. Marko believes that ABC Co. can generate cash flows of $5,500, $10,500, and $16,700 over the next three years, respectively. After that time, they feel the business will be worthless. Marko has determined that a rate of return of 13 percent is applicable to this potential purchase. What is Marko willing to pay today to buy ABC Co.?

Answer 1

Answer:

Marko is willing to pay $24,664 today to buy ABC Co.

Explanation:

Present values of all the cash flows will decide the today's value of the investment.

Present values

Required rate of return = CF ( 1 + r )^-n

First year = $5,500 x ( 1 + 0.13 )^-1 = $5,500 x ( 1.13 )^-1 = $4,867

Second year = $10,500 x ( 1 + 0.13 )^-2 = $10,500 x ( 1 .13 )^-2 = $8,223

Third year = $16,700 x ( 1 + 0.13 )-3 = $16,700 x ( 1.13 )-3 = $11,574

Net present value of all cash flows = $4,867 + $8,223 + $11,574 = $24,664