A series of cash flows may not always necessarily be an annuity. Cash flows can

Question

A series of cash flows may not always necessarily be an annuity. Cash flows can also be uneven and variable in amount, but the concept of the time value of money will continue to apply Consider the following case: The Purple Lion Beverage Company expects the following cash flows from its manufacturing plant in Palau over the next three years: Annual Cash Flows Year 1 Year 2 Year 3 $400,000 $37,500 $180,000 The CFO of the company believes that an appropriate annual interest rate on this investment is 9%. what is the present value of this uneven cash flow stream, rounded to the nearest whole dollar? O $2,175,000 O $2,392,500 O $617,500 O $537,528 Identify whether the situations described in the following table are examples of uneven cash flows or annuity payments: Annuity Payments Uneven Description Cash Flows Shania bought a new dress for her brother's wedding for $450. She negotiated a deal with the retailer in which she would pay for the dress in three installments of $250, $100, and $100 over the next three months You signed up to make a monthly payment of $10 for one year for a lifetime tosubscription to your favorite magazine British consols are British government bonds that promise to make payments of a specified amount at regular intervals to the bearer forever You receive interest earnings from variable dengsits in a reqular

Explanation / Answer

1. Last option is the correct answer: 537,528

2. a. Shania's installment is a example of uneven cash flows as the amount of installment is not equal and differs at every stage.

b. MOnthly payment of $10 for lifetime is the example of even cash flows as the amount of cash outflow is same in all the years

c. The Brithish government bond promising to pay a specific amount is a example of even cash flows as the amount of cash flows would be equal at regular intervals.

3. Nominal interest aret = 8.80%

Periodic interest rate = 8.80% / 4 = 2.20% (rate divided by 4 as the interest is compounded quarterly)

Effective interest rate = (1+8.80%/4)1*4 - 1 = 9.09%

4. Effective interest rate Rahul would pay = (1+8%/365)365 - 1 = 8.328%

5.

Year Cash flows PVF Factor Present Value 1 400000 0.917 366972 2 37500 0.842 31563 3 180000 0.772 138993 Present Value 537,528

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