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Dear John,
Value of spinning off department B:
Present value of year 1 $7.62m X 120% X 0.909 = $8.31m
Present value of year 2 onwards $9.14m X (1+5.2%)/(10%-5.2%) x 0.909= $ 182.11The year 1cash flow is discounted by 1 year discount factor which is 0.909. But why year 2 still using the 1 year discount factor 0.909. Discount that terminal value to present time shouldn’t it use 0.826?
Thank you
I will answer this, but in future you must use the Ask the Tutor Forum if you want me to answer – this forum is for students to help each other.
You are happy (I think) about using the dividend valuation formula in order to get the present value of an inflating perpetuity.
However that formula gives the present value on the basis that the first flow is in 1 years time. Here, the first flow is in 2 years time (1 year later than time 1) and therefore the formula gives a PV one year later as well (at time 1 instead of at time 0). So we need to discount the answer by 1 year to account for the fact that it is one year later.Hope that helps 🙂
Thank you very much, sir. It’s clear for me now.
I’m ll post my question as your request in the future.
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