4. You own an oil pipeline which will generate a $2 million cash return over the
ID: 2670790 • Letter: 4
Question
4. You own an oil pipeline which will generate a $2 million cash return over the comingyear. The pipeline’s operating costs are negligible, and it is expected to last for a very
long time. Unfortunately, the volume of oil shipped is declining, and cash flows are
expected to decline by 4 percent per year. The discount rate is 10 percent.
a) What is the PV of the pipeline’s cash flows if its cash flows are assumed to last
forever?
b) What is the PV of the cash flows if the pipeline is scrapped after 20 years?
Explanation / Answer
Expected cash flow next year2million Discount rate10% Fall in cash flow @ 4% per year PV of pipeline cash flow14.29 million b) Year CF DF@10% PV 1 2 0.909091 1.82 2 1.92 0.826446 1.59 3 1.84 0.751315 1.38 4 1.77 0.683013 1.21 5 1.70 0.620921 1.05 6 1.63 0.564474 0.92 7 1.57 0.513158 0.80 8 1.50 0.466507 0.70 9 1.44 0.424098 0.61 10 1.39 0.385543 0.53 11 1.33 0.350494 0.47 12 1.28 0.318631 0.41 13 1.23 0.289664 0.35 14 1.18 0.263331 0.31 15 1.13 0.239392 0.27 16 1.08 0.217629 0.24 17 1.04 0.197845 0.21 18 1.00 0.179859 0.18 19 0.96 0.163508 0.16 20 0.92 0.148644 0.14 PV 13.35
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