2012H2 FIN101 XC03 – Lowpoint coffee example

Lowpoint coffee’s after-tax cash flows are currently $100,000 annually but will grow at 3% indefinitely.  With a 15% discount rate how much should Starbucks offer to takeover this mom-and-pop coffee shop assuming a 15% discount rate?

Using the present value of a growing annuity formula:

Internally, Starbuck’s knows this is what Lowpoint is worth.  However, upper management would like to offer $750,000 instead.  At what interest rate can a $750,000 offer be justified?  Just rearrange the PVA formula a bit:

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