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A company has annual after-tax operating cash flows of $2m per year which are expected to continue in perpetuity. The company has a cost of equity of 10%, a before-tax cost of debt of 5% and an after-tax weighted average cost of capital of 8% per year. Corporation tax is 20%.
What is the theoretical value of the company?
Answer :- Theoretical value = 2m/0.08 = $25m
hello sir ,can you please explain what the theoretical value means here and how it is calculated in this situation? is there any formula to calculate it ?
As I explain in my free lectures, the theoretical value of the company is calculated by discounting the after-tax operating flows at the WACC.
Given that the after-tax flows are $2M per year in perpetuity and that the discount factor for a perpetuity is 1/r (where r in this case is the WACC of 8%), then the value of the company is indeed 2M/0.08.
Have you watched all of my free lectures? They are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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