Considerafirmthathasexistingassetsinwhichithascapital
investedof$100million.Assumethesefouradditionalfacts
about the firm.
1.Theafter-taxoperating incomeonassetsinplace is$15
million. This return on capital of 15% is expected to be
sustainedinperpetuityandthecompanyhasacostofcapital
of 10%.
2.Atthebeginningofeachofthenextfiveyears,thefirmis
expected to make investments of $10 million each. These
investments are also expectedto earn 15%as a return on
capital and the cost of capital is expected to remain 10%.
- After year 5, the company will continue to make
investmentsandearningswillgrow5%ayear,butthenew
investmentswillhaveareturnoncapitalofonly10%,which
is also the cost of capital.
4.All assets andinvestments areexpectedto haveinfinite
lives.
12 Thus,theassetsinplaceandtheinvestmentsmadeinthe
firstfiveyearswillmake15%ayearinperpetuity,withno
growth.
This firm can be valued using an economic value added
approach, as shown in the followingtable (in millions of
dollars).