At the beginning of 2014, market analysts expect Atlantis Company, holder of a v

Question

At the beginning of 2014, market analysts expect Atlantis Company, holder of a
valuable patent, to earn the following stream of economic profits over the next five
years. At the end of five years, Atlantis will lose its patent protection, and analysts
expect economic profit to be zero after five years.
Year
Expected Economic
Profit
2014 $225,000
2015 $325,000
2016 $425,000
2017 $200,000
2018 $100,000
a. If investors apply an annual risk-adjusted discount rate of 15 percent, the
value of Atlantis Company in 2014 is $______________________, which is
also the maximum price they would be willing to pay for Atlantis.

a. $726,916

b. $884.912

c. $1,275,000

d. $2,215,000

e. $3,824,318

Explanation / Answer

The discounted rate is calculated as 1/(1+i)n

i = 15% = 0.15

Discounted cash flow = Economic Profit * discounted rate

The value of Atlantis Company in 2014 is the sum of the dicounted cash flows = $884912

Ans) b. $884912

Economic profit Discounted rate Discounted cash flow 225000 0.8695652174 195652.173913043 325000 0.7561436673 245746.691871456 425000 0.6575162324 279444.398783595 200000 0.5717532456 114350.649118607 100000 0.4971767353 49717.673529829

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