A project generates the following sequence of cash flows over six years. Year Ca
ID: 2383456 • Letter: A
Question
A project generates the following sequence of cash flows over six years.
Year Cash Flow ($ million)
0 -59.0
1 4.00
2 5.00
3 6.00
4 7.33
5 8.00
6 8.25
a. Calculate the NPV over the six years. The discount rate is 11%.
b. This project does not end after the sixth year but instead will generate cash flows far into the future. Estimate the project's terminal value, assuming that cash flows after year 6 will continue at $8.25 million per year in perpetuity, and then recalculate the investment's NPV.
c. Calculate the terminal value assuming that cash flows after the sixth year grow at 2% annually in perpetuity, and then recalculate the NPV.
d. Using market multiples, calculate the terminal value by estimating the project's market value at the end of year 6. Specifically, calculate the terminal value while assuming that, at the end of year 6, the project's market value will be 10 times greater than its most recent annual cash flow. Recalculate the NPV.
Explanation / Answer
A. Calculate the NPV over the six years. The discount rate is 11%
NPV over the six years = 26.034.
B. Estimate the project's terminal value
T.V = T0 = FCFN+1/(k – g)
T0 is the value of future cash flows at a future point in time
which is immediately prior to N+1, or at the end of period N,
which is the final year in the projection period,
k being the discount rate.
g being the growth rate.
year Cash Flow ($ million) P.V factor 11% P.V 0 -59.0 1 -59.0 1 4.00 .9009 3.6036 2 5.00 .8116 4.0580 3 6.00 .7311 4.3866 4 7.33 .6587 4.8282 5 8.00 .5934 4.7472 6 8.25 .5346 4.4104 Total 38.58 4.2303 26.034Related Questions
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