UNEVEN CASH PAYMENTS

 Present Value of Uneven Cash Payments

 Future Value of Uneven Cash Payments

WHAT IS PRESENT VALUE?

To find the present value of uneven cash flows, we first need to calculate the
present value of each cash flow and then add them.

The present value is a keystone in the time value of money concept because this
technique is developed to evaluate any assets from financial instruments (e.g., stocks
and bonds) with respect to the value of the entire corporation. A large proportion of assets
generate uneven or irregular cash flow, making the process of their valuation
cumbersome. Common examples of an uneven cash flow stream are dividends on
common stock, coupon payments on a floating-rate bond, or the free cash flow of a
business. Since the value of each cash flow in the stream can vary and occur at irregular
intervals, the present value of uneven cash flows is calculated as the sum of the present
values of each cash flow in the stream.

FORMULA:

CF0 CF1 CF2 CFN

PV = 0 + 1 + 2 +…+
(1 + r) (1 + r) (1 + r) (1 + r)N

Illustrative Example:
 It is expected that $1,500 will be received at the end of the first year, $1,850 at the
end of the second year, $2,100 at the end of the third year, $2,500 at the end of the fourth
year, and $2,950 at the end of the fifth year. Let’s find the present value of the cash flow
stream if the discount rate is 15.75%.
The present value of the first cash flow (CF1) amounts to $1,295.90, CF2 is
$1,380.80, CF3 is $1,354.12, CF4 is $1,392.69, and CF5 is $1,419.77.

PV of CF1 = $1,500 ÷ (1 + 0.1575)1 = $1,295.90

PV of CF2 = $1,850 ÷ (1 + 0.1575)2 = $1,380.80
PV of CF3 = $2,100 ÷ (1 + 0.1575)3 = $1,354.12
PV of CF4 = $2,500 ÷ (1 + 0.1575)4 = $1,392.69
PV of CF5 = $2,950 ÷ (1 + 0.1575)5 = $1,419.77

Thus, the present value of the uneven cash flow stream will be $6,843.27.
Present Value Factors

1st Year 0.86393088552

2nd Year 0.74637657496

3rd Year 0.64481777534

4th Year 0.55707799165

5th year 0.48127688263

WHAT IS FUTURE VALUE?

The future value of uneven cash flows is the sum of future values of each cash
flow. It can also be called “terminal value.” Unlike annuities where the amount of payment
is constant, many financial instruments and assets generate cash flows that can vary from
period to period. For example, dividends on common stock and coupon payments of a
floating rate bond can vary. Cash flow generated by business activity is another common
example of uneven or irregular cash flows.
 As was mentioned above, the future value of an uneven cash flow stream is the
sum of the future values of each cash flow. To determine this sum, we need to compound
each cash flow to the end of the stream as shown in the formula below.

FV = CF0 × (1 + r) N + CF1 × (1 + r) N-1 + CF2 × (1 + r) N-2 + … + CFN

Illustrative Example:

$1,000 is expected to be received at the end of the first year, $800 at the end of
the second year, $1,100 at the end of the third year, $700 at the end of the fourth year,
and $1,050 at the end of the fifth year. It may be possible to reinvest received cash
flows at an annual interest rate of 12%. To find the future value of the cash flow stream,
we need to find the future value of each cash flow. The first cash flow (CF 1) will be
reinvested for 4 years, CF2 for 3 years, CF3 for 2 years, CF4 for 1 year, but CF5 won’t be
reinvested because it is expected to be received at the end of the fifth year.

FV of CF1 = $1,000 × (1+0.12) (5-1) = $1,573.52

FV of CF2 = $800 × (1+0.12) (5-2) = $1,123.94
FV of CF3 = $1,100 × (1+0.12) (5-3) = $1,379.84
FV of CF4 = $700 × (1+0.12) (5-4) = $784.00
FV of CF5 = $1,050 × (1+0.12) (5-5) = $1,050.00

Thus, the total future value of the uneven cash flow stream is $5,911.30.
FUTURE VALUE FACTORS:

1st Year 1.57351936

2nd Year 1.404928

3rd Year 1.2544

4th Year 1.12

5th year 1