Question

Your best friend is opening a vintage clothing store and wants you to invest. For only $35,000 today, she will offer you a perpetual stream of cash flows representing a dividend from the potential profits. Those cash flows to you will vary for the first three years; and thereafter will grow at 1.5% annually and in perpetuity. (Just for clarification, this means that, based on the estimated Year 3 cash dividend of $12,000, the Year 4 cash flow to you will be $12,180 and the Year 5 cash flow will be $12,363.) This small chart represents the first three years of the proposal Year Cash Flow 2 (35,000) 2,000 10,000 12,000 You are intrigued, but worried: failure in the retail industry is rampant. You decide that you will assign it a risk-adjusted discount rate of 30%. What is the Net Present Value of all of your expected cash flows, including the (negative) up-front investment outflow and the perpetuity at the end of vour forecast? O A. ($14,888) B. ($2,917) O C.(S 2,805) O D. (S 2,630) O E.S 13,54:3

Answer 1

NPV = Investment+ CF1/(1+r)¹ + CF2/(1+r)² + CF3/(1+r)³ + (CF3(1+g)/r-g)/(1+r)³

= -35000 + 2000/(1.3)¹ +10000/(1.3)²​​​​​​​ + 12000/(1.3)³ + (12000(1.015)/(0.3-0.015))/(1.3)³

^{= -35000 + 1538.46 + 5917.16 + 5462 + 19452.36}

^{= -2630}

^{Ans) D}