#4. (10pts) Bay Properties is considering starting a commercial real estate divi
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Question
#4. (10pts) Bay Properties is considering starting a commercial real estate division. It has prepared the following four-year forecast of free cash flows for this division.Show your work Year O 900 Year 1 $25,000 Year 2 $22,000 Year $20,000 Year 4 $30,000 Free cash $300,000 flow Assume cash flow after year 4 will grow at 3% per year, forever. If the cost of capital for this division is 14%, what is continuation value in year 4 for cash flows after year 47(5pts) Calculate NPV of this project and what is the divison's decision on this project? (5pts)Explanation / Answer
Year
Cash Flow(C)
0
$ (300,000)
1
$ 25,000
2
$ 22,000
3
$ 20,000
4
$ 30,000
5
$ 30,900
6
$ 31,827
7
$ 32,782
8
$ 33,765
Present value of growing perpetuity cash flows:
PV = C/r-g
C = Initial cash flow = $ 30,900
r = Discount rate = 14 % or 0.14
g = Growth rate = 3 % or 0.03
PV = $ 30,900/0.14 – 0.03 = $ 30,900/0.11 = $ 280,909.09
Putting this value in year 5th cash flow, we get the present value of project as:
Year
Cash Flow(C)
PV Factor(F) '@ 14 %
PV(=C x F)
0
$ (300,000)
1/(1+0.14)^0
1
$ (300,000.00)
1
$ 25,000
1/(1+0.14)^1
0.87719298
$ 21,929.82
2
$ 22,000
1/(1+0.14)^2
0.76946753
$ 16,928.29
3
$ 20,000
1/(1+0.14)^3
0.67497152
$ 13,499.43
4
$ 30,000
1/(1+0.14)^4
0.59208028
$ 17,762.41
5
$ 280,909.09
1/(1+0.14)^5
0.51936866
$ 145,895.38
NPV
$ (83,984.67)
As NPV is negative Project should not be acceptable.
Year
Cash Flow(C)
0
$ (300,000)
1
$ 25,000
2
$ 22,000
3
$ 20,000
4
$ 30,000
5
$ 30,900
6
$ 31,827
7
$ 32,782
8
$ 33,765
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