Question

At the end of 2019, Uma Corporation is considering a major long-term project in an effort competitive in its industry. The production and sales departments have determined the potential annual cash flow savings that could accrue to the firm if it acts soon. Specifically, they estimate that a mixed stream of future cash flow savings will occur at the end of the years 2021 through 2026. The years 2027 through 2031 will see consecutive and equal cash flow savings at the end of each year. The firm estimates that its discount rate over the first 6 years will be 7%. The expected discount rate over the years 2027 through 2031 will be 11%. The project managers will find the project acceptable if it results in present cash flow savings of at least $860,000. The following cash flow savings data are supplied to the finance department for analysis.
a. Determine the value (at the beginning of 2019) of the future cash flow savings expected to be generated by this project.
b. Based solely on the one criterion set by management, should the firm undertake this specific project? Explain.
c. What is the "interest rate risk," and how might it influence the recommendation made in part b? Explain.
Discount rate for years 2020 - 2025 7%
Discount rate for years 2026 - 2030 11%
Cash Present
Year Year (n) Flow Value
2020 1 $110,000
2021 2 120,000
2022 3 130,000
2023 4 150,000
2024 5 160,000
2025 6 150,000
2026 7 90,000
2027 8 90,000
2028 9 90,000
2029 10 90,000
2030 11 90,000
Could you please fill the present value for each year in excel and showing me the formula for each year?
The concept of interest-rate risk states that changes in the interest rates may adversely affect the value of an investor's securities portfolio. While this is not a securities problem, the relationship between the change in rates and the subsequent change in the value of an asset hold true. If the the interest rates were to rise just 1%, the present value of the expected savings would fall below the required $860,000 limit set by mangement.

Answer 1

Answer:

A. $820,036.47

B. No, the firm should not undertake this specific project

C. If the interest rate go higher by 1 percent the risk is that the present cash flow savings limits of the amount of $860,000 set by the management will fall.

Explanation:

a. Calculation to Determine the value of the future cash flow savings expected to be generated by this project.

PRESENT VALUE

2020 = $110,000/(1.07)^1

2020= $102,803.74

2021= $120,000/(1.07)^2

2021=$104,812.65

2022 =$130,000/(1.07)^3

2022=$106,118.72

2023 =$150,000/(1.07)^4

2023=$114,434.28

2024 =$160,000/(1.07)^5

2021=$114,077.79

2025 =$150,000/(1.07)^6

2025=$99,951.33

2026 =$90,000/(1.11)^7

2026=$433,49.26

2027 =$90,000/(1.11)^8

2027=$39,053.38

2028 =$90,000/(1.11)^9

2028=$351,83.23

2029 =$90,000/(1.11)^10

2029=$31,696.60

2030 =$90000/(1.11)^11

2030=$28,555.49

TOTAL VALUE $820,036.47

Therefore the value of the future cash flow savings expected to be generated by this project is $820,036.47 .

b. Based on the criterion that was set by the management, the firm should NOT undertake this specific project reason been that the total amount of the PRESENT VALUE (PV) cash inflow of the amount of $820,036.47 is LESSER than the present cash flow savings of the amount of $860,000 that was set by the management.

c. Based on the information given in a situation were the interest rate go higher by 1 percent the risk is that the present cash flow savings limits of the amount of $860,000 set by the management will fall.