You have recently learned that the company where you work is being sold for 275000$ and income statements indicates current profit of 10000$ and interest remain constant at 10 % what constant rates does the owner believe that profits will grow? Does this seem reasonable?
Heydb
To determine the constant growth rate that the owner believes the profits will grow by, we can use the Gordon Growth Model. This model assumes that the value of a company is equal to the present value of its future cash flows, which includes dividends or profits.
The formula for the Gordon Growth Model is:
Value of the Company = Future Cash Flow / (Discount Rate - Growth Rate)
In this case, the future cash flow is the anticipated profit, which is $10,000. The discount rate is the interest rate of 10%, which remains constant. Let's assume the growth rate is "g." Therefore, the formula becomes:
$275,000 = $10,000 / (0.10 - g)
We can rearrange the equation to solve for the growth rate:
$275,000 * (0.10 - g) = $10,000
0.10 - g = $10,000 / $275,000
0.10 - g = 0.03636
g = 0.10 - 0.03636
g ≈ 0.0636 (or 6.36%)
According to the calculation, the owner believes that the profits will grow at a constant rate of approximately 6.36%.
The reasonableness of this growth rate depends on various factors, including the company's industry, historical growth rates, market conditions, and future business plans. Without additional information, it is challenging to determine if this growth rate is reasonable. However, a constant growth rate of 6.36% might be considered a moderate expectation for many businesses. It is essential to conduct a thorough analysis and consider various factors to assess the reasonableness of the estimated growth rate.