Question

The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is "looking up." As a result, the cemetery project will provide a net cash inflow of $92,000 for the firm during the first year, and the cash flows are projected to grow at a certain rate forever. The project requires an initial investment of $1,500,000. At what constant growth rate would the company just break even if it still required a return of 13 percent on investment?

Answer 1

Value after first year would be=(Cash flow for 1st year*(1+Growth rate))/(Required return-Growth rate)

=(92000*(1+Growth rate))/(0.13-Growth rate)

=(92000+92000*Growth rate)/(0.13-Growth rate)

Hence current value=Future cash flows and value*Present value of discounting factor(rate%,time period)

1,500,000=92000/1.13+(92000+92000*Growth rate)/(0.13-Growth rate)/1.13

1,500,000-81415.9292=[(92000+92000*Growth rate)/(0.13-Growth rate)]*0.884955752

(1,500,000-81415.9292)/0.884955752=[(92000+92000*Growth rate)/(0.13-Growth rate)]

1603000*(0.13-Growth rate)=92000+92000*Growth rate

208390-1603000*Growth rate=92000+92000*Growth rate

Growth rate=(208390-92000)/(92000+1603000)

=6.867%(Approx)