Franklin Industries has a current net working capital of $2.5 million. It expects that this will grow at a rate of 3.5% annually forever. If it could slow that growth to 3% per year, how would that affect the value of the firm, given that it has a cost of capital of 11%?
A)an increase of $2.08 million
B)a decrease of $2.22 million
C)an increase of $12 500
D)an increase of $0.78 million

Question

Quizplus · Accepted Answer

The value of the firm increases when the growth rate of net working capital decreases because less capital is tied up in working capital, allowing more free cash flow to be available to investors. The difference in value can be calculated using the formula for the value of a perpetuity: Value = (Cash Flow / (Cost of Capital - Growth Rate)). The decrease in growth rate from 3.5% to 3% reduces the denominator, increasing the value of the firm. The specific increase of $2.08 million is calculated based on the given figures and the formula.

Franklin Industries Has a Current Net Working Capital of $2