Your consulting firm will produce cash flows of $175,000 this year, and you expe

Question

Your consulting firm will produce cash flows of $175,000 this year, and you expect cash flow to keep pace with any increase in the general level of prices. The interest rate currently is 5.5%, and you anticipate inflation of about 1.5%. a. What is the present value of your firm's cash flows for years 1 through 5? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Present value b. How would your answer to (a) change if you anticipated no growth in cash flow? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Present value

Explanation / Answer

(a) Computation of the present value of your firm's cash flows for years 1 through 5.We have,

Present value of cash flow = CF0 (1+I1 ) / (1+ R1) + CF0 (1+I1 )2 / (1+ R1)2 +CF0 (1+I1 )3 / (1+ R1)3 + CF0 (1+I1 )4 / (1+ R1)4 + CF0 (1+I1 )5 / (1+ R1)5

Where,

CF0 = Cash flow for current year = $ 175,000

I = Inflation rate = 1.5%

R = Rate of interest = 5.5 %

putting these value in the above formula.We get,

Present value of cash flow = 175,000(1.015)/ (1.055) +175,000(1.015)2/ (1.055)2+175,000(1.015)3/ (1.055)3+175,000(1.015)4/ (1.055)4 + 175,000(1.015)5/ (1.055)5

Present value of cash flow = 168,365 + 161,981 + 155,840 + 149,931 + 144,247

Present value of cash flow = $ 780,364

(b) Computation of the present value of cash flow if no growth in cash flow.We have,

Rate of interest = 5.5 %

Current year cash flow = $ 175,000

Present value of cash flow = Current year cash flow x PVIFA(5.5%,5 year)

Present value of cash flow = 175,000 x 4.270 = $ 747,300

Present value of cash flow $ 780,364

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