Question

Fijisawa Inc. is considering a major expansion of its product line and has estimated the following cash flows associated with such an expansion. The initial outlay would be

​$1,900,000​, and the project would generate incremental free cash flows of $500,000 per year for 7 years. The appropriate required rate of return is 6 percent.

a. Calculate the NPV

b. Calculate the PI.

c. Calculate the IRR.

d. Should this project be​ accepted?

Answer 1

a) Calculation of NPV:

Initial outlay = $1900000

Incremental free cash flows = $500000 for 7 years

Requires rate of return = 6%

Present value of cash inflows = $500000*Present value annuity factor(6%,7)

= $500000*5.5824 = $2791200

NPV = Present value of cash inflows - Initial outlay = $2791200 - $1900000 = $891200

b) Calculation of PI:

Present value of cash inflows = $2791200

Initial outlay = $1900000

PI = Present value of cash inflows/Present value of cash inflows = $2791200/$1900000 = 1.469

c) Calculation of IRR:

IRR is given by:

Present value of cash inflows = Initial outlay

$500000*Present value annuity factor(r,7) = $1900000

Present value annuity factor(r,7) = $1900000/$500000

Present value annuity factor(r,7) = 3.8

Now, we have to find the value of IRR whose annuity value is 3.8 for 7 years.

If we take IRR as 18% then annuity value is 3.8. So, IRR is 18%.

d) This project should be accepted because IRR is greater than required rate of return and NPV is also positive.