The Yurdone Corporation wants to set up a private cemetery business. According t

Question

The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is "looking up". As a result, the cemetery project will provide a net cash inflow of $97,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 4 percent per year forever. The project requires an initial investment of $1,500,000.
Yurdone's required return is 11 percent.
The company is somewhat unsure about the assumption of a 4 percent growth rate in its cash flows. At what constant growth rate would the company just break even if it still required an 11 percent return on investment?

Explanation / Answer

We need to equate the present value of cashflows to initial Investment

Present Value of a Increasing Perpretuity = Cash Flows in Year1/(Required rate- growth rate)

Let g be growth rate

Then 97000/(0.11-g) = 1500000

Solving for g

1500000(0.11-g) = 97000

165000-97000= 1500000g

g = 0.0453333 = 4.53%

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