Franklin Industries has a current net working capital of $1 million.It expects that this will grow at a rate of 3% annually forever.What growth rate in working capital would the firm require in order to achieve a $2 million increase in firm value,given that it has a cost of capital of 7%?
A)2%
B)2.7%
C)3.3%
D)1.4%
E)4%

Question

Quizplus · Accepted Answer

The value of the increase in working capital can be calculated using the formula for the present value of a perpetuity: PV = C / r, where C is the annual cash flow and r is the discount rate. To find the growth rate that would result in a $2 million increase in firm value, we set the increase ($2 million) equal to the present value of the growing perpetuity formula: $2 million = ($1 million * growth rate) / (0.07 - growth rate). Solving for the growth rate gives approximately 2.7%.

Franklin Industries Has a Current Net Working Capital of $1