Jay's Jams Inc. was just established with an investment of $5 million in 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

To find the market value of Jay's Jams Inc., we need to calculate the present value of its future cash flows, using the cost of capital of 15%. Using a financial calculator or spreadsheet, the present value of the cash flows can be calculated as:

PV = $800,000 / (1 + 0.15)^1 + $800,000 / (1 + 0.15)^2 + ... + $800,000 / (1 + 0.15)^10
+ $1,000,000 / (1 + 0.15)^11 + $1,000,000 / (1 + 0.15)^12 + ... + $1,000,000 / (1 + 0.15)^20
PV = $9,673,352

Therefore, the market value of Jay's Jams Inc. is $9.67 million.

The book value of Jay's Jams Inc. is simply the initial investment of $5 million. Therefore, the correct answer is option C) Market value = $5.3 million; book value = $5.0 million.