Over the next three years, a firm is expected to earn economic profit of $200,000 in the first year, $300,000 in the second year, and $250,000 in the third year. After the end of the third year, the firm goes out of business. If the risk-adjusted discount rate is 9 percent for each of the next three years,
1. The firm can be sold today for a price of $______________.
2. The value of the firm is $______________.
The value of the firm is the sum total of the present value of economic profits of each of the three years at the given risk-adjusted discount rate.
Calculate the value of the firm -
Value = [$200,000/(1+0.09)1] + [$300,000/(1+0.09)2] + [$250,000/(1+0.09)3]
Value = [$200,000/(1.09)1] + [$300,000/(1.09)2] + [$250,000/(1.09)3]
Value = [$200,000/1.09] + [$300,000/2.18] + [$250,000/3.27]
Value = $183486.24 + $137614.68 + $76,452.60
Value = $397,553.52
Thus,
The firm can be sold today for a price of $397,553.52.
The value of the firm is $397,553.52.
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Exhibit 4-3 Supply and demand curves
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A. is not the expected outcome of this game.
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