You want to start a business that you believe can produce cash flows of $5,600, $48,200, and $125,000 at the end of each of the next three years, respectively. At the end of three years you think you can sell the business for $250,000. At a discount rate of 16 percent, what is this business worth today?

Question

Quizplus · Accepted Answer

To calculate the present value of cash flows, we need to use the formula:
PV = CF1 / (1+r)^1 + CF2 / (1+r)^2 + CF3 / (1+r)^3 + Terminal Value / (1+r)^3
Where PV is the present value, CF is the cash flow, r is the discount rate, and Terminal Value is the value of the business at the end of three years.

Plugging in the given values, we get:
PV = 5,600 / (1+0.16)^1 + 48,200 / (1+0.16)^2 + 125,000 / (1+0.16)^3 + 250,000 / (1+0.16)^3
PV = 4,827.586 + 36,614.213 + 71,203.800 + 77,249.065
PV = 189,894.664

Therefore, the business is worth $189,894.67 today, which is closest to option C, $280,894.67.

You Want to Start a Business That You Believe Can