Question

You are the manager of a construction company with a five-year project that has a projected net cash flow of $25,000, $35,000, $45,000, $20,000 and $15,000. Implementation costs are $50,000. The company has a required rate of return of 20%. Compute the discounted cash flow and determine the NPV. Include your calculations in an appendix after the references page. Include information on what projected net cash flow, discounted cash flow and NPV are, why they are useful in project selection, and, given the numbers, if this example project meets the company requirements, and why or why not.

Answer 1

Cash Flows:
Year 0 = -$50,000
Year 1 = $25,000
Year 2 = $35,000
Year 3 = $45,000
Year 4 = $20,000
Year 5 = $15,000

Required Return = 20%

Discounted Cash Flows:

Year 1:

Discounted Cash Flow = $25,000 / 1.20
Discounted Cash Flow = $20,833.33

Year 2:

Discounted Cash Flow = $35,000 / 1.20^2
Discounted Cash Flow = $24,305.56

Year 3:

Discounted Cash Flow = $45,000 / 1.20^3
Discounted Cash Flow = $26,041.67

Year 4:

Discounted Cash Flow = $20,000 / 1.20^4
Discounted Cash Flow = $9,645.06

Year 5:

Discounted Cash Flow = $15,000 / 1.20^5
Discounted Cash Flow = $6,028.16

NPV = -$50,000 + $20,833.33 + $24,305.56 + $26,041.67 + $9,645.06 + $6,028.16
NPV = $36,853.78

Discounted cash flows and NPV are useful for project selection as the management can evaluate the profitability of the project using expected cash flows.

NPV of the project is positive. So, this project should be selected.