Your client wants to buy a business that provides financial advice to local smal

Question

Your client wants to buy a business that provides financial advice to local small businesses. The firm generated $650,000 in cash flows during the previous year, and the discount rate to value firms in this sector is 11%. The firm’s cash flows are expected to grow by 5% (which includes 3% for expected inflation). The firm is registered as a corporation, and it is expected to continue operating indefinitely into the future. Based on this information, how much should your client pay for this business?

Explanation / Answer

OCF(last year)= 650000

OCF(one year ahead,1)= 650000*(1.11)^2 =800865 (beacuse discount rate of 11 %)

now we will use the formula OCF/(k-g) to calculate value of the firm in year 1

800865/(.11-.05)=13347750

and its present value will be 13347750/1.11 =1213431.82 which should be paid by the client

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