Jay's Jams Inc.was just established with an investment of $5 million into stereo equipment.Jay expects his company to generate $800,000 a year for the next 10 years, followed by $1 million a year for the following 10 years.If Jay's cost of capital is 15%, find the market value and book value of his company.(Use values in millions)
A)Market value = $9.0 million; book value = $5.0 million
B)Market value = $5.0 million; book value = $5.3 million
C)Market value = $5.3 million; book value = $5.0 million
D)Market value = $7.0 million; book value = $5.0 million

Question

Quizplus · Accepted Answer

To find the market value of Jay's Jams Inc., we need to calculate the present value of the expected future cash flows. We can do this using the formula:

PV = CF1 / (1 + r)^1 + CF2 / (1 + r)^2 + ... + CFn / (1 + r)^n

where PV is the present value, CF1 to CFn are the expected cash flows, and r is the cost of capital.

For the first 10 years, the expected cash flows are $800,000 per year, so we can plug in the values:

PV = $800,000 / (1 + 0.15)^1 + $800,000 / (1 + 0.15)^2 + ... + $800,000 / (1 + 0.15)^10

Solving this equation gives us a present value of approximately $5.3 million for the first 10 years.

For the next 10 years, the expected cash flows are $1 million per year. Using the same formula, we get:

PV = $1,000,000 / (1 + 0.15)^11 + $1,000,000 / (1 + 0.15)^12 + ... + $1,000,000 / (1 + 0.15)^20

Solving this equation gives us a present value of approximately $3.7 million for the next 10 years.

Adding these two present values together, we get a total present value of approximately $9.0 million. This is the market value of Jay's Jams Inc.

To find the book value, we simply take the initial investment of $5 million and subtract any depreciation or amortization. Since no depreciation or amortization is given, the book value is simply $5 million.

Therefore, the best choice is C, Market value = $5.3 million; book value = $5.0 million.