The other 75% are owned by the Willard family. Hoda acquired the shares eight years ago through a financing transaction. Each year, Hoda has received a dividend from Willard. Willard has been in business for 60 years, and continues to have strong operations and cash flows. Hod a must determine the fair value of this investment at its year end. Since there is no market on which the shares are traded, Hoda must use a discounted cash flow model to determine fair value. Hoda management intends to hold the shares for five more years, at which time, they will sell the shares to the Willard family under an existing agreement for $million. There is no uncertainty in this amount. Management expects to receive dividends of 1 $80,000 for each of the five years, although there is a 20% chance that dividends could be $50,000 each year. The risk-free rate is 4% and the risk-adjusted rate is 6%.
Instructions
(a) Identify some of the items Hod a will need to consider in determining the fair value of the investment.
(b) Calculate the fair value of the investment in Willard using the traditional approach.
(c) Calculate the fair value of the investment using the expected cash flow approach.
(d) In this case, which discounted cash flow model is the best and why?