Valuing Acme Medical Corp. using the Discounted Cash Flow Model

    Valuing Acme Medical Corp. using the Discounted Cash Flow Model Valuing a company's future cash flows is essential for determining the fair value of its shares. In this essay, we will explore the valuation of Acme Medical Corp. using the discounted cash flow (DCF) model. We will also calculate the value of each share based on the given information and the weighted average cost of capital (discount rate) of 7%. Lastly, we will analyze the impact of an increase in the discount rate to 10% on the present value of cash flows and the value of each share. A. Present Value of Acme's Future Cash Flows To calculate the present value of Acme Medical Corp.'s future cash flows, we will use the discounted cash flow model. The cash flows from 2018 to 2022 are given in the table, and after 2022, a growth rate of 3% is expected annually. Using the formula for calculating the present value of future cash flows: PV = CF1 / (1 + r)^1 + CF2 / (1 + r)^2 + ... + CFn / (1 + r)^n Where PV is the present value, CF is the cash flow in each year, r is the discount rate, and n is the number of years. Using the given cash flows and a discount rate of 7%, we find: PV = 500,000 / (1 + 0.07)^1 + 550,000 / (1 + 0.07)^2 + 620,000 / (1 + 0.07)^3 + 700,000 / (1 + 0.07)^4 + 800,000 / (1 + 0.07)^5 ≈ $3,187,996.92 Therefore, the present value of Acme Medical Corp.'s future cash flows using the discounted cash flow model is approximately $3,187,996.92. B. Value of Each Share To calculate the value of each share, we need to consider the number of common shares outstanding, preferred shares, and debt with a market value. Given that there are 200,000 common shares outstanding and no preferred shares, we can calculate the value per share by dividing the total value of the company by the number of common shares: Value per Share = (Value of Equity + Value of Debt) / Number of Common Shares Value of Equity = Present Value of Cash Flows Value of Debt = Market Value of Debt Value per Share = ($3,187,996.92 + $10,000,000) / 200,000 ≈ $56.94 Therefore, the value of each share in Acme Medical Corp., with 200,000 common shares outstanding and debt with a market value of $10,000,000, is approximately $56.94. C. Impact of Increased Discount Rate If the discount rate increases to 10%, both the present value of cash flows and the value per share will change. Re-calculating the present value of cash flows using a discount rate of 10%, we find: PV = 500,000 / (1 + 0.10)^1 + 550,000 / (1 + 0.10)^2 + 620,000 / (1 + 0.10)^3 + 700,000 / (1 + 0.10)^4 + 800,000 / (1 + 0.10)^5 ≈ $2,847,609.55 Therefore, with a discount rate of 10%, the present value of Acme Medical Corp.'s future cash flows decreases to approximately $2,847,609.55. Re-calculating the value per share with the updated present value and other given information: Value per Share = ($2,847,609.55 + $10,000,000) / 200,000 ≈ $64.24 Therefore, with a discount rate of 10%, the value of each share in Acme Medical Corp. would be approximately $64.24. In conclusion, valuing a company's future cash flows using the discounted cash flow model allows for a determination of its fair value. By considering factors such as cash flows, discount rates, and other outstanding obligations like debt and preferred shares, investors can estimate the value per share and make informed investment decisions based on their risk tolerance and investment objectives.  

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