At the end of 2019, Uma Corporation is considering 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 2020 through 2025. The years 2026 through 2030 will see consecutive $90,0000 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 2026 through 2030 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.

Create spreadsheets similar to Table 5.3, and then answer the following questions.

a. Determine the value (at the end of 2019) 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.

Table 5.3

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Year 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Cash flow savings $110,000 120,000 130,000 150,000 160,000 150,000 90,000 90,000 90,000 90,000 90,000