You own an oil pipeline which will generate a $2 million cash return over the coming year.

Question:

You own an oil pipeline which will generate a $2 million cash return over the coming year. The pipeline’s operating costs are negligible, and it is expected to last for a very long time. Unfortunately, the volume of oil shipped is declining, and cash flows are expected to decline by 4 percent per year. The discount rate is 10 percent.

a. What is the PV of the pipeline’s cash flows if its cash flows are assumed to last forever?

b. What is the PV of the cash flows if the pipeline is scrapped after 20 years?

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...