Question

An investment, which has an expected return of 9.5%, is expected to make annual cash flows forever. The first annual cash flow is expected in 1 year and all subsequent annual cash flows are expected to grow at a constant rate of 2.5% per year. We know that the cash flow expected in 1 year from today is expected to be $5,400. What is the present value (as of today) of the cash flow that is expected to be made in 3 years from today? a. $4,321.15 (plus or minus $10.00) b. $4,731.66 (plus or minus $10.00) c. $5,268.29 (plus or minus $10.00) d. $4,429.18 (plus or minus $10.00) e. None of the above is within $10.00 of the correct answer

Answer 1

D

Step-by-step explanation:

Present value is the sum of discounted cash flows

Present value can be calculated using a financial calculator

Cash flow in year 3 = $5,400 x 1.025³ = $5815.21

Cash flow in year 1 and 2 = 0

Cash flow in year 3 = $5815.21

I = 9.5%

Present value = $4,429.18

To find the PV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute