Question

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annual return on U.3 At the end of 2019, Uma Corporation is considering a major long-term project effort to remain competitive in its industry. The production and sales departmen determined the potential annual cash flow savings that could accrue to the firm if i soon. Specifically, they estimate that a mixed stream of future cash flow savings occur at the end of the years 2020 through 2025. The years 2026 through 2030 consecutive $90,0000 cash flow savings at the end of each year. The firm estimate its discount rate over the first 6 years will be 7%. The expected discount rate years 2026 through 2030 will be 11% in an ents have HEET EXERCISE will see s t at low savings of at least $860,000. The following cash flow savings data are supplied. to the finance department for analysis. The project managers will find the project acceptable if it results in present cash Year 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Cash flow savings $110,000 120,000 130,000 150,000 160,000 150,000 90,000 90,000 90,000 90,000 90,000 TO DO Create spreadsheets similar to Table 5.3, and then answer the following questions. a. Determine the value (at the end of 2019) of the future cash flow savings expected b. Based solely on the one criterion set by management, should the firm undertake c. What is the "interest rate risk," and how might it influence the recommendation to be generated by this project. this specific project? Explain. made in part b: Explain.

Answer 1

1: We determine the present value of cash flows as CF/(1+r)^n, then add them up to arrive at the present value of the cash flows.

Value at the end of 2019= 820036.49 (As per spreadsheet below)

Year	N	Cash flows	PV of cash flows
2020	1	110000	102803.74
2021	2	120000	104812.65
2022	3	130000	106118.72
2023	4	150000	114434.28
2024	5	160000	114077.79
2025	6	150000	99951.33
2026	7	90000	43349.26
2027	8	90000	39053.38
2028	9	90000	35183.23
2029	10	90000	31696.60
2030	11	90000	28555.50
	Value at the end of 2019		820036.49

2: The project will not be accepted since its PV is lesser than $860,000

3: Interest rate risk is the risk that the interest rate may not be as estimated by the management. It may be greater than that in which case the present value will be even lower. If it is lower than that, the PV may be higher in which case the project may have a value of more than $860,000 and in that case it will be wrong to reject the project.

WORKINGS