Practice Question
If a company expects to generate cash flows of $100,000 for the first 5 years, followed by a perpetual growth of 4%, and the discount rate is 10%, what is the present value of the cash flows from year 6 onwards?
Answer +
B
Step-by-step solutions +
Step 1: Calculate the cash flow in Year 6:
$100,000 × (1 + 0.04) = $104,000
Step 2: Apply the Growing Perpetuity Formula:
PV at Year 5 = $104,000 / (0.10 - 0.04) = $1,733,333
Step 3: Discount PV at Year 5 back to today:
$1,733,333 / (1.10)^5 = $1,070,000
Conclusion: The present value of cash flows from Year 6 onward is approximately $1,070,000.
$100,000 × (1 + 0.04) = $104,000
Step 2: Apply the Growing Perpetuity Formula:
PV at Year 5 = $104,000 / (0.10 - 0.04) = $1,733,333
Step 3: Discount PV at Year 5 back to today:
$1,733,333 / (1.10)^5 = $1,070,000
Conclusion: The present value of cash flows from Year 6 onward is approximately $1,070,000.