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.
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 = $18.0 million; book value = $5.0 million

Question

Quizplus · Accepted Answer

The book value is the initial investment of $5 million. The market value is the present value of future cash flows, which is calculated using the cost of capital. The present value of the cash flows ($800,000 for 10 years and $1 million for the next 10 years) at a 15% discount rate is approximately $5.3 million.