Question

An investment is expected to generate annual cash flows forever. The first annual cash flow is expected in 1 year and all subsequent annual cash flows are expected to grow at a constant rate annually. We know that the cash flow expected in 3 year(s) from today is expected to be 1,420 dollars and the cash flow expected in 9 years from today is expected to be 2,660 dollars. What is the cash flow expected to be in 5 years from today?

Answer 1

Since the annual cash flows are expected to grow at a constant rate, we have to compute the annual growth rate for each year to determine the cash flows for each year.

Cash flow at the end of 3 years = $1,420

Cash flow at the end of 9 years = $2,660

Applying the compounded annual growth rate (CAGR) formula, in excel

CAGR = [(Cash flow at period 9) / (Cash flow at period 3) ^ (1 / no. of years between year 3 and 9) - 1]

CAGR = ($2,660 / $1,420) ^ (1 / 6) - 1 = 11.03%

Therefore, annual growth rate in cash flows = 11.03%

Cash flow expected at the end of 5 years = Cash flow at end of 3 years * (1 + Growth rate) ^ 2

Cash flow at the end of 5 years = $1,420 * (1 + 11.03%) ^ 2 = $1,750.46

answered by: anonymous