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Investment / Financial Markets Old Exam MFE Forum 

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#1




Rate of Growth Question
From ASM: A project requires an immediate investment of 19 million. It is expected to generate free cash flows of 2 million per year at the end of the first year, growing 2% per year perpetually. The cost of capital is 12%.
Perform a breakeven analysis on the rate of growth of free cash flows. The solution is given as : Let g be the growth rate. We want to solve −19 + 2/(0.12g)=0 giving g= 0.01474 Isn't g already given as 2%? Can anyone please explain the difference between g=2% and g= 0.01474 (1.474%)? Thanks!
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#2




Not sure, and I don’t have the textbooks or ASM. I think the idea is that the project is expected to be profitable, but they aren’t sure that the growth rate will be as high as 2%. So they want to know how low the growth rate could be and the project still break even, considering the cost of capital.

#3




Quote:
What you are asked to calculate is the growth rate such that the net present value of the project is zero. It is a hypothetical quantity generally different from the real growth rate. Perhaps the solution can denote the breakeven growth rate by another symbol like g^(breakeven) to distinguish it from g = 2%. In fact, the 2% real growth rate is not required for solving the problem.
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Ambrose Lo, PhD, FSA, CERA Associate Professor of Actuarial Science (with tenure) Department of Statistics and Actuarial Science The University of Iowa ACTEX Manual for SOA Exam PA  ACTEX Manual for SOA Exam SRM  ACTEX Manual for CAS Exam MASI Textbook: Derivative Pricing: A ProblemBased Primer (useful for derivatives portion of Exam IFM) 
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