At the end of 2015, Uma Corporation is considering undertaking a major long-term
project in an effort to remain 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 2016 through 2021. The years
2022 through 2025 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 2022 through 2027 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.
End of year	Cash flow savings
2,016.00	110,000.00
2,017.00	120,000.00
2,018.00	130,000.00
2,019.00	150,000.00
2,020.00	160,000.00
2,021.00	150,000.00
2,022.00	90,000.00
2,023.00	90,000.00
2,024.00	90,000.00
2,025.00	90,000.00
2,026.00	90,000.00
To Do
Create spreadsheets similar to Table 5.2, and then answer the following questions.
a. Determine the value (at the beginning of 2017) 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.
a.
Discount rate for years 2016 - 2021		7%
Discount rate for years 2022 - 2027		11%
		Cash		Present
Year	Year (n)	Flow		Value
2016	1	$110,000		110,000.00
2017	2	120,000
2018	3	130,000
2019	4	150,000
2020	5	160,000
2021	6	150,000
2022	7	90,000
2023	8	90,000
2024	9	90,000
2025	10	90,000
2026	11	90,000
Reminder:
First, we will discount cash flows for year 2022 to 2026 at 11%.
Next, we will discount cash flows for Year 2016 to 2021 at 7%.
Present value of cash flows for year 2022 to 2026 at the end of year 2021 is $332,630.73.
by discounting cash flows for Year 2016 to 2021 at 7%, we get PV of 863,844.42.