Question

Assume a new investment project is expected to generate $1,000 and $1,000 in free cash flows for two years (2021 (first year) and 2022 (Second year)), respectively. The forecasted annual inflation is 2 % a year. Show (4) the actual (or real) free cash flow (after inflation rate is considered) in 2021 (First Year) and 2022 (Second Year). If WACC is 10%, what is the (5) present value of the investment (Investment year is 2020)

Answer 1

Answer:

(4) The the actual (or real) free cash flow (after inflation rate is considered)

2021 (First Year): $980.39

2022 (Second Year): $961.17

(5) Present value of the investment (Investment year is 2020) is $1,735.54

Explanation:

Free cash flow in 2021: $1000

Free cash flow in 2022: $1000

WACC (discounting rate): 10%

(4) The the actual (or real) free cash flow (after inflation rate is considered) in 2021 (First Year) and 2022 (Second Year):

FCF in 2021 after considering inflation = $1000/(1+2%) = $980.39

FCF in 2022 after considering inflation = $1000/((1+2%)^2) = $961.17

(5) Present value of the investment (Investment year is 2020)

PV = Cash flow in year 1/(1+ discounting rate) + Cash flow in year 2/(1+ discounting rate)^2

= 1000/(1+10%) +1000/((1+10%)^2)

=1,735.54