Hi,
Do you know how can we solve this question:
Thank you again :)
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I'm assuming that "owns 100% of his company" means that there is no debt. Basically he can receive cash flows of $100 that will grow by 2% each year or accept a lump sum of $1250. So it's about finding the cost of equity that makes the DDM equal to $1250 ( = 100 / [x - .02] ). Solving for that you get 10% as the cost of equity.
Theoretically I think it's all about what type of return the owner was originally expecting based on the risk of owning the business. If he was expecting a return over 10%, the cash flows from dividends would be worth less than $1250, so he should accept the lump sum.
Curious to hear others' thoughts on this.
^agreed. pretty much the CF/r equation adjusted to include growth rate.
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