The head of the accounting department at a major software ma

The head of the accounting department at a major software manufacturer has asked you to put together a pro forma statement of the company\'s value under several possible growth scenarios and the assumption that the company’s many divisions will remain a single entity forever. The manager is concerned that, despite the fact that the firm’s competitors are comparatively small, collectively their annual revenue growth has exceeded 50 percent over each of the last five years. She has requested that the value projections be based on the firm’s current profits of $5.1 billion (which have yet to be paid out to stockholders) and the average interest rate over the past 20 years (6 percent) in each of the following profit growth scenarios:

a. Profits grow at an annual rate of 8 percent. (This one is tricky.) (Click to select)

This growth rate is not possible

The firm\'s value is infinite

The firm\'s value is zero

The firm will have to shut down at this growth rate

Instructions: Round your responses to 2 decimal places.

b. Profits grow at an annual rate of 3 percent.

____ billion

c. Profits grow at an annual rate of 0 percent.

____ billion

d. Profits decline at an annual rate of 4 percent.

____ billion

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Solution

a. Profits grow at an annual rate of 8 percent.

This growth rate is not possible.

The manager’s concern is that though the competitors are comparatively small, their collective annual growth has exceeded 50 percent over each of the last five years. Moreover, the interest rate stands at an average of 6 percent over the last 20 years. It is difficult to get to an annual growth rate of 8 percent.

b. Profits grow at an annual rate of 3 percent.

5.25 billion. ($5.1 billion is the base profit for that year. 3% annual rate is = 103 / 100 x 5.1 = $5.25 billion.).

c. Profits grow at an annual rate of 0 percent.

$5.1 billion. Since there is zero growth rate, profit will remain the same without any change.

d. Profits decline at an annual rate of 4 percent.

$4.89 billion. (4% decline in profit is = 96 / 100 x 5.1 = $4.89).

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