A company forecasts growth of 6% for 5 years and 3% thereafter. Given last year's cash flow was $100, what is the horizon value if the company cost of capital is 8%?
A) $0
B) $1,672
C) $2,000
D) $2,676

Question

Quizplus · Accepted Answer

Horizon value is the value of a company's expected cash flows beyond a certain point in the future.

Here, the growth rate for the first 5 years is given as 6% and 3% thereafter.

To calculate the horizon value, we need to first calculate the cash flow at the end of year 5. This can be calculated using the following formula:

Cash flow at year 5 = Cash flow at year 4 x (1 + growth rate)
= $100 x (1 + 6%)^4
= $136.05

We can then calculate the cash flow at the end of year 6 by applying the growth rate of 3% as follows:

Cash flow at year 6 = Cash flow at year 5 x (1 + growth rate)
= $136.05 x (1 + 3%)
= $140.18

We can continue this process to calculate the cash flows for each year. Alternatively, we can use the formula for the perpetuity growing at a constant rate:
PV = C/(r-g)

where PV is the present value of the perpetuity, C is the cash flow in the first year, r is the discount rate and g is the growth rate.

Using this formula, we can calculate the horizon value as follows:

HV = (Cash flow at year 6 x (1+g))/(r-g)
= ($140.18 x 1.03)/(0.08 - 0.03)
= $2,675.74 ≈ $2,676

Therefore, the correct choice is D, $2,676.

A Company Forecasts Growth of 6% for 5 Years and 3