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Chapter 12. Question 16

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A. The discounted cash flow of $2 million for the first year is $. (Round to the nearest dollar.)

Correct! The discounted cash flow of $2 million for one year is $1,851,852.
Inorrect! The discounted cash flow of $2 million for one year is calculated by dividing $2 million by 1.08. Rounding to the nearest dollar results in $1,851,852.

B. The number of years it will take to recover the initial $10 million investment is years. (Provide the answer as a whole number.)

Correct! It will take 7 years to recover the initial investment.
Incorrect! It would take 7 years. Continue the calculation from the first part of the problem to determine the present value for subsequent years. The present value of $2 million collected for year 2 is $2 million / (1.08)2 = $1,714,678. Continuing these calculations by dividing $2 million by (1.08)n for each year (n = 3, 4, 5…), the present value of total future revenues will exceed $10 million after year 7. (Year 3 = $1,587,664; Year 4 = $1,470,060; Year 5 = $1,361,166; Year 6 = $1,260,339; Year 7 = $1,166,981.)

For further review, see section “Present Value Approach” (link to section in ebook).