Mr Piper owns and operates a family pickling company.he expects earnings (revenu

ID: 2666875 • Letter: M

Question

Mr Piper owns and operates a family pickling company.he expects earnings (revenues less costs including taxes) for next year to be 3 million. for next 5 years(year 2 to 6) he expects that earing will grow at an annual rate of 20%, but that all of them will have to be reinvested in the company. thereafter he expects that earnings will grow at an annual rate of 5 %, and that only 40% of them will have to be reinvested.
Krafty foods, Inc, has just offered Mr.Piper $20 million for his company. determine whether or not this is a fair offer if the cost of capital for Mr. Piper is 14%.

Explanation / Answer

Years

Expected earnings

3000000

3600000

3000000*(1+0.20)

4320000

3600000*(1+0.20)

5184000

4320000*(1+0.20)

6220800

5184000*(1+0.20)

7464960

6220800*(1+0.20)

earnings

600000

3000000*0.20

720000

3600000*0.20

864000

4320000*0.20

1036800

5184000*0.20

1244160

6220800*0.20

earnings will grow at an annual rate of 5 %,

30000

600000*5%

36000

720000*5%

43200

864000*5%

51840

1036800*5%

62208

1244160*5%

223248

On 223248 30% only reinvested 223248*30$ = 66974.4

Total(223248 + 7464960) = 7688208

So Crafty foods, Inc, offer is fair offer