Cash flows have been estimated in detail for the first six years of a new venture's life. Management feels the new business will go on indefinitely, and will probably grow at an average rate of 3% per year starting at $50M in year seven. The project is being evaluated using a cost of capital of 11%. What is the contribution of this terminal value assumption to the sixth year cash flow?
A)$50M
B)$625M
C)$455M
D)$1,667M

Question

Quizplus · Accepted Answer

The terminal value at the end of year 6, considering a growth rate of 3% and a cost of capital of 11%, can be calculated using the formula for a perpetuity with growth: Terminal Value = Cash Flow Year 7 / (Cost of Capital - Growth Rate) = $50M / (0.11 - 0.03) = $50M / 0.08 = $625M. This represents the present value at the end of year 6 of all future cash flows from year 7 onwards.

Cash Flows Have Been Estimated in Detail for the First