Question

Your consulting firm will produce cash flows of $125,000 this year, and you expect cash flow to keep pace with any increase in the general level of prices. The interest rate currently is 6.5%, and you anticipate inflation of about 2.5%.

a. What is the present value of your firm’s cash flows for years 1 through 6? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b. How would your answer to (a) change if you anticipated no growth in cash flow? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Year1 cashflow=$125,000

From Year2 onwards, it grows at 2.5% per year

Year2 cashflow=$125,000*(1+2.5%)=$128,125

Year3 cashflow=$128,125*(1+2.5%)=$131,328

Year4 cashflow=$131,328*(1+2.5%)=$134,611

Year5 cashflow=$134,611*(1+2.5%)=$137,977

Year6 cashflow=$137,977*(1+2.5%)=$141,426

Present value of firm cashflows=(125,000/(1+6.5%))+(128125/(1+6.5%)^2)+(131328/(1+6.5%)^3)+(134611/(1+6.5%)^4)+(137977/(1+6.5%)^5)+(141426/(1+6.5%)^6)

=117370.9+112962.6+108719.9+104636.5+100706.5+96924.08

=$641,320.42

2. If growth rate ise zero, the cashflows of $125,000 remains same for all the six years.

Present value of firm's cashflows=(125,000/(1+6.5%))+(125,000/(1+6.5%)^2)+(125,000/(1+6.5%)^3)+(125,000/(1+6.5%)^4)+(125,000/(1+6.5%)^5)+(125,000/(1+6.5%)^6)

=117370.9+110207.4+103481.1+97165.4+91235.1+85666.8
=$605,126.7

answered by: anonymous