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.

Question

Quizplus · Accepted Answer

The market value of the company is calculated as the present value of the expected cash flows, which are $800,000 per year for the first 10 years and $1 million per year for the next 10 years. Using a 15% discount rate, the market value is calculated as follows:

Market Value = $800,000 * (1 - 1 / (1 + 0.15) ^ 10) / 0.15 + $1,000,000 * (1 - 1 / (1 + 0.15) ^ 20) / 0.15
             = $4,965,026.99

The book value of the company is simply the initial investment of $5 million. Therefore, the correct answer is C, with a market value of $4,965,026.99 and a book value of $5 million.