8. Consider your firm’s uneven cash flow analysis presented to you for the vario

Question

8. Consider your firm’s uneven cash flow analysis presented to you for the various scenarios given below and of course for your calculation:

Show your calculations on this sheet or attach an additional page.

               Year                                      Cash Flow

                 0                                          $2,000   

                 1                                            2,000  

                 2                                                   0  

                 3                                            1,500  

                 4                                            2,500  

                 5                                            4,000  

What is the present value (Year 0) of the cash flow stream if the opportunity cost rate is 10 percent?

       b. What is the future value (Year 5) of the cash flow stream if the cost flows are invested in an account and the opportunity cost rate is 10 percent?

c. What is cash flow today (Year 0), in lieu of the $2,000 cash flow, would be needed to accumulate 20,000 at the end of Year 5? (Assume that the cash flows for Years 1 through 5 remain the same)?

d. Time value analysis involves either discounting or compounding cash flows. Many healthcare financial management decisions such as bond refunding, capital investment, and lease buys involve discounting projected future cash flows. What factors must executives consider when choosing a discount rate to apply to forecasted cash flows?

Explanation / Answer

a. Present value at 10% discount interest rate:

b. Future Value :

c. Cash flow at Year 0 so that Future Value at the end of 5th year accumulate to 20000 (Assume that the cash flows for Years 1 through 5 remain the same) :

cash flow at the year 0 = 20000 - 16300.50 (from part b) = 3699.50 + 2000 = $5699.50

So, the cash flow at the year 0 is $5699.50 and from year 1 to year 5 remains the sameand opportunity cost rate of 10% will provide us $20000 accumulated at the end of Year 5.

d. Financial Management decisions such as bond refunding, capital investment, and lease buys involves discounting projected future cash flows, so an executives have to consider following factors while choosing a discount rate :

1) Should be based on the opportunity cost principle.

2) Must be in parity with the expected return on the alternatives.

3) The discount rate should be adjusted according to the riskiness of the cash flows.

4) The discount rate followed in the economy affecting the current return required.

5) The rate of return of the various other alternatives, will determine the discount rate to be choosen.

year cash flow $ discount rate present value $ 0 2000 1 2000 1 2000 0.909 1818 2 0 0.826 0 3 1500 0.751 1126.50 4 2500 0.683 1707.50 5 4000 0.621 2484 Total $9136

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