You own a wholesale plumbing supply store. The store currently generates revenue

Question

You own a wholesale plumbing supply store. The store currently generates revenues of $1.05 million per year. Next year revenues will either decrease by 10.5% increase by 5.5%, with equal probability, and then stay at that level as long as you operate the store. You own the store outright. Other costs run $890,000 per year. There are no costs to shutting down; for $540,000. What is the business worth today if the cost of capital is fixed at 10.2%? (Hint: Make sure to round all intermediate calculations to at least four decimal places.) in that case you can always sell the store What is the business worth today if the cost of capital is fixed at 10.2%? Today the business is worth S(Round to the nearest dollar.)

Explanation / Answer

We need to first determine the periodic csah flow,

For t=1, revenue $1.05mn

Cost = $890,000

So, t=1 cash flow = $1,050,000 - $890,000 = $160,000

from t=2 onwards, the sale either decline by 10.5% or increase by 4.4% nd then remain constant with equal probability, hence

Sales in t=2 = 0.5 x (1,050,000 x 1.055) + 0.5 x (1,050,000 x (1-10.5%)) = $133,750

since this is a perpetual cash flow, so we can determine the terminal value from it as,

(133,750)/0.102 = $1,311,275

Adding the selling price for store of $540,000, we get terminal value as $1,851,275.

So, total worth of the busines today is = $160,000 + $1,851,275) 1 (1 + 1.102) = $1,825,113

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