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© Copyright 2002-2003. All rights reserved.
Page 15
How To Investigate Any Business Opportunity
* -Based on 40% rate of return. The discount factor declines in each succeeding year.
* * - Present value of the sum of discounted projected cash flows. This figure is added to the residual
value of the business to arrive at the total value of the business.
Step #3
One more calculation must now be done - the residual value of the business. The residual value is the
present value of the business's estimated net worth at the end of the period of projected cash flows (in
this example, at the end of five years). This is calculated by adding the current net worth of the business
and future annual additions to the net worth. The annual additions are defined as the sum of each year's
after-tax earnings, assuming no dividends are paid to stockholders. These additions are added to the
current net worth, and that total is discounted to its present value to yield the residual value.
Step #4
The residual value is added to the present value sum of the projected future cash flows previously com-
puted to arrive at a price for the business. An example follows.
After Tax Income
Year 1 $125
Year 2 $131
Year 3 $138
Year 4 $144
Year 5 $152
               ______
Total Additions to net worth $690
Current net worth $910
             ______
Total net worth $1600
Residual Value (1600 x.186) $298* * *
*** - Multiplying the total net worth by the discount factor used in the final year of projected cash flows
yields the residual value. Adding the residual value of $298 to the present value sum of projected cash
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