Calculation of Value of the firm When a firm earns a stream of economic profit for a number of years in the future,

the value of a firm is the present value of the future economic profits expected to be generated by the firm.

Value of a firm= 1/(1+r) + 2/(1+r)+.+T/(1+r)T= t/(1+r)t

is the economic profit expected in period t r is the risk adjusted discount rate T is the number of years in the life of a firm The larger the risk associated with future profits, the higher the risk adjusted discount rate used to compute the value of the firm, and the lower will be the value of the firm. Calculation of Present value of the future payment The payment you would accept today rather than wait for a payment (or stream of payments) to be received in the future is called present value of the future payment. The process of calculating the present values is some times refer to discounting since the present value of a payment is less than the future amount. To properly discount the Rs.100 future payment, you must first determine the opportunity cost of waiting for your money. Suppose at no risk, you could earn a return on 6 per cent by investing the money over a period of one year. This 6 % return is called the risk free discount rate since it determines the rate at which you will discount future payment to determine their present value, assuming you bear no risk of receiving less than the promised amount. Given that you can earn 6 per cent on your money, how much money do you need now? Say Rs. X is that money Therefore, Rs. X (1.06) is the value of Rs.X Rs. X (1.06) = Rs. 100) = 100/1.06=94.34 (for one year) (100/(1.06)2 =89 (for two years). Therefore, the present value of Rs. 100 to be received int years (t being any number of years) with discount rate of 6 per cent is Present Value =Rs.100/(1.06)t