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The Chandler Group wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is "looking up". As a result, the cemetery project will provide a net cash inflow of $57,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 7 percent per year forever. The project requires an initial investment of $759,000. The firm requires a 14 percent return on such undertakings. The company is somewhat unsure about the assumption of a 7 percent growth rate in its cash flows. At what constant rate of growth would the company just break even?

Respuesta :

Answer: 6.49%

Explanation:

The constant rate of growth where the company would break even will be calculated thus:

Initial investment = Net cash inflow / (14% - g)

759000 = 57,000/(0.14 - g)

where g = growth rate

759000 = 57,000/(0.14 - g)

Cross multiply

759000(0.14 - g) = 57000

106260 - 759000g = 57000

759000g = 106260 - 57000

759000g = 49260

g = 49260/759000.

g = 0.0649

g = 6.49%

Parrain

The growth rate that would lead the business to breakeven is 6.49%.

At breakeven, the growth rate would lead to the cash inflows from the project being just enough to pay back the initial investment put into the catering business.

This growth rate is calculated by the formula:

Growth rate = ( (Investment * return rate) * - First cash inflow) / Investment

= ( (759,000 * 14%) - 57,000) / 759,000

= 6.49%

The growth rate that would lead the business to breakeven is therefore 6.49%.

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