Question

Green Forest Media is evaluating a 1-year project that would involve an initial investment in equipment of 38,900 dollars and an expected cash flow of 42,600 dollars in 1 year. The project has a cost of capital of 8.65 percent and an internal rate of return of 9.51 percent. If Green Forest Media were to use 38,900 dollars in cash from its bank account to purchase the equipment, the net present value of the project would be 307 dollars. However, Green Forest Media has no cash in its bank account, so using money from its account is not possible. Therefore, the firm would need to borrow money to raise the 38,900 dollars. If Green Forest Media were to borrow money to raise the 38,900 dollars, the interest rate on the loan would be 1.3 percent. Green Forest Media would receive 38,900 dollars from the bank at the start of the project and would pay 39,406 dollars to the bank in 1 year. What is the NPV of the project if Green Forest Media borrows 38,900 to pay for the project?

Answer 1

Answer; NPV of the project with loan is $2,939.71 as per the working shown in the screen shot below:

1 Option: Bank finance 2 Cost of capital (r)= 8.65% 3 Cash outflow at the end of year 1 for loan repayment (a) $39,406 4 Project revenue after one year (b) $42,600 5 NPV is the excess of present value of (b) over the PV of (a) discounted at the cost of capital 6 PV of revenues=b/(1+r) = $42600/(1+0.0865)= $39,208.47 7 PV of outflow for repayment=a/(1+r) = $39406/(1+0.0865)= $36,268.75 8 NPV of the project with loan=PV of revenues-PV of outflow =$39208.47-$36268.75 $2,939.71 14