The Weldon Electronics Corporation is about to begin producing and selling its p

Question

The Weldon Electronics Corporation is about to begin producing and selling its prototype product. Annual cash flows for the next five years are forecasted as:

Year   Cash Flow

1 -$100,000

2 -$50,000

3 $50,000

4   $400,000

5   $800,000

A. Assume that the Year 6 cash flows are forecasted to be $1,000,000 in the stepping stone year and are expected to grow at a 5 percent compound annual rate thereafter. Assuming that the investors still want a 50 percent rate of return on their investment, calculate the venture

Explanation / Answer

Calculation is similar to how we do for Stocks & Dividends.

Constant Growth begins at End of Y6.

So P6= D7/(Ks-g) = D6*(1+g)/(Ks-g)

= 1000000*(1+5%)/(50%-5%) = 2,333,333

So HV = P6 = 2,333,333

So PV = -100000/(1+50%)^1-50000/(1+50%)^2+50000/(1+50%)^3 +400000/(1+50%)^4+800000/(1+50%)^5 + 2333333/(1+50%)^6

= $315,135 .............Ans (a)

Constant Growth begins at End of Y6.

So P6= D7/(Ks-g) = D6*(1+g)/(Ks-g)

= 1000000*(1+5%)/(25%-5%) = 5,250,000

So HV = P6 =5,250,000

So PV = -100000/(1+50%)^1-50000/(1+50%)^2+50000/(1+50%)^3 +400000/(1+50%)^4+800000/(1+50%)^5 + 5250000/(1+50%)^6 = $571,193 ..............Ans (b)

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