School

Simon Fraser UniversityDepartment

Business AdministrationCourse Code

BUS 207Professor

Allan MatadeenThis

**preview**shows half of the first page. to view the full**3 pages of the document.**Present value of indefinitely lived assets

PV (perpetuity) =CF/i (i is the interest). Examples of such an asset include perpetual bonds and

preferred stocks. I.e. the value of a perpetual bond that pays the owner $100 at the end of each

year when the interest rate is fixed at 5 percent is given by PV=100/0.05=2000

Present value analysis is also useful in determine the value of the firm, since the value of the

firm is the present value of the stream of profits (cash flow) generated by the firm’s physical,

human, and intangible assets. In particular, if pi(0) is the firm’s current level of profits, then

pi(1) is the next year’s profit, and so on. Therefore the value of the firm is:

PV(firm)=pi(0)+pi(1)/(1+i)+pi(2)/(1+i)^2+pi(3)/(1+i)^3+.....

In other words, the value of the firm today is the present value of its current and future profits.

Notice that the value of the firm takes into account the long-term impact of managerial

decisions on profits. So the goal of the firm is to maximize the present value of current and

future profits.

Profit maximization

As previously mentioned, the profit maximization is to maximize the present value of current

and future profits.

Suppose a firm’s current profits are pi(0), and that these profits have not yet paid out to

shareholders as dividends. Imagine that these profits are expected to grow at a constant rate of

g percent each year, and that profit growth is less than the interest rate (g<i). In this case,

www.notesolution.com

###### You're Reading a Preview

Unlock to view full version