The cash flow in year 1 is $2,000. Starting year 2, the cash flow will grow...
The cash flow in year 1 is $2,000.
Starting year 2, the cash flow will grow at X% per year forever.
The initial cost is $6,000.
The required return is 16%.
The net present value of this project is $10,000.
What does X need to be?
Homework Answers
We will be using a constant growth model for the cash flows for and beyond year 2 and as we will get the PV of the cash flows till year 1 we will further discount it by 1.16 to get the PV at year 0. the following is the Constant growth model-
PV at year 1 = [Cash flow in year 1 (1+ growth rate) ]/ ( Required return - Growth rate)
PV at year 0 = [Cash flow in year 1 (1+ growth rate) ]/ ( Required return - Growth rate) *( 1+ required rate)
NPV is the sum of the present value of all the cash flows.
$10,000 = -$6,000 + ($2,000/1.16) + [$2000*( 1+ X%) / (1.16*(16%-X%))
Solving the above equation for x
We get X = 0.035 or 3.5%
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