Question

The business plan for KnowIt, LLC, a start-up company that manufactures portable multigas detectors, showed equivalent annual cash flows of $400,000 for the first 5 years. If the cash flow in year 1 was $311,000 and the constant increase thereafter was $50,000 per year, what interest rate was used in the calculation?

Answer 1

Since the company plans for equivalent cash flow of $400000 for five year but actaully there was contant inc. in cash flow for 50000 per yr from the first yr cash flow of 311000, thus int. rate can be calculated equating the NPV (Net present Value) of diff. of two type of cash flow with 0 .Thus,

Putting, NPV of Differences =0,

By Hit and trail method,

Using Int. rate be 10% then NPV would be -6393

Again using Int.rate 12% then NPV would be 338

then using approximation formula,

Int. rate = Lower rate + (Amount which makes the NPV zero/Total diff. b/w two NPV)* Diff. b/w two rates

=10% + (6393/6731)*2

=11.899%, Approx 11.9%

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