1. You are considering investing in a high-end retail store located on South Bea

Question

1. You are considering investing in a high-end retail store located on South Beach. The store has a 10-year lease, which implies that it will remain in business for the next 10 years. It produced annual cash flows of $400,000 (after all expenses were deducted), and the discount rate to value similar businesses is 10%. You estimate that, over the long-term, cash flows will grow at 5% per year because of inflation expectations. Therefore, the expected cash annual cash flow for next year is $420,000 [or $400,000(1.05)].   Based on this information, what is the estimated value of the store?

2. You and your partner from college started a new business venture that consists of a health and athletic club to promote a healthier lifestyle. Your accountant estimates that the firm generated $650,000 in cash flows during the previous year, and the appropriate 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). Since the business is a corporation, it is expected to continue operating indefinitely into the future. Based on this information, what is the value of the business?

3. You recently learned that one of your wealth management clients has $350,000 to invest. She wants to be able to withdraw $18,500 every year forever without depleting (or using up) any of her principal. What interest rate would her investment have to earn in order for her to be able to do so?

4. You won a $10 million lottery prize, and have been presented with several options:

Option 1: Take the $10 million today   
Option 2: Take a $12 million lump sum in 2 years
Option 3: Take a $15 million lump sum in 5 years
Option 4: Take a $20 million lump sum in 8 years

Assuming a discount rate of 10%, which payout option should you take?

Explanation / Answer

Solution 1:

The estimated value of the store will be : Free cash flow * growth rate / Discount - growth rate

= 400000 *1.05/ .1-.05

= 420000/ .05

= 8400000

8400000* PVIF 10% 10 year

= 8400000 * 1/1.1^10

= 3238200

Solution 4:

option 1: present value = $10 million

option 2: 12 * PVIF 2 years, 10%

= 12*.8264

=991680

Option 3:

15*.6209

=931350

Option 4:

20*.4665

=933000

Hence he should take 10 million today

solution 3:

The interest rate would be

18500/350000

= 5.2%

solution 2:

Tot compute the value of business we need to find the cash flow indefinitely

hence = 650000*1.02/ (.11- .02)

.02 = growth rate because .05- inflation

Value of the firm = 7366666.67

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