David West has been working on a new technology to improve m

David West has been working on a new technology to improve manufacturing performance. His technology will be available in the near term. He estimates his first annual cash flow from the technology to be $500,000, received three years from today. Subsequent annual cash flows will grow at 5 percent in perpetuity. What is the present value of the technology if the discount rate is 10 percent? Please show your work.

Solution

Value after year 3=(Cash flow for year 3*Growth rate)/(Discount rate-Growth rate)

=(500,000*1.05)/(0.1-0.05)

=$10,500,000

Hence present value of technology=Future cash flows*Present value of discounting factor(10%,time period)

=500,000/1.1^3+$10,500,000/1.1^3

which is equal to

=$8,264,462.81(Approx).