Question

An investment is expected to generate 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 annually. We know that the cash flow expected in 4 years from today is expected to be $7500 and the cash flow expected in 5 years from today is expected to be $9000. What is the cash flow expected to be in 2 years from today?

Answer 1

Answer:

$5,208

Explanation:

First we need to calculate the growth rate using following formula

Growth Rate = (Final Value - Initial Value) / Initial Value

Placing Values in the formula = ($9,000 - $7,500) / $7,500 = $1,500 / $7,500 = 0.2 = 20%

As the cash flow in growing on constant rate of 20%. We need to calculate the prior years cash flow using following formula.

Cash Flow after growth = Current Cash flow ( 1 + growth rate)

Year 3 cash flow

$7,500 =  Cash Flow of Year 3 ( 1 + 20% )

Cash Flow of Year 3 = $7,500 / 120%

Cash Flow of Year 3 = $6,250

Year 2 cash flow

$6,250 =  Cash Flow of Year 2 ( 1 + 20% )

Cash Flow of Year 3 = $6,250 / 120%

Cash Flow of Year 3 = $5,208