MaritimeTV Emporium, a national retailer of flat panel screens, is investigating an opportunity to purchase Maritime TV and Sound Inc. An acquisition is expected to lower overhead costs, improve distribution efficiencies, and improve ordering volumes from the major manufacturers. If those improvements (synergies) are implemented, TV Emporium financial staff estimate the following incremental net cash flows to be $5 million, $5.6 million, and $6.9 million for the first three years. Cash flows would grow at 3% thereafter. Maritime TV and Sound's tax rate is 30%. Its cost of equity is 10%.
-Refer to Scenario: Maritime.What is the horizontal value of Maritime's operation as of year 3?

Question

Quizplus · Accepted Answer

The horizontal value of Maritime's operation as of year 3 can be calculated using the formula for a perpetuity from year 3 onwards: $PV = \frac{CF_{year4}}{r-g}$, where $CF_{year4}$ is the cash flow in year 4, $r$ is the cost of equity, and $g$ is the growth rate. The cash flow in year 4 is the year 3 cash flow grown by 3%, so $CF_{year4} = 6.9 \times 1.03 = 7.107$ million. The cost of equity $r = 10\%$, and the growth rate $g = 3\%$. Plugging these into the formula gives $PV = \frac{7.107}{0.10 - 0.03} = \frac{7.107}{0.07} = 101.53$ million.

MaritimeTV Emporium, a National Retailer of Flat Panel Screens, Is