Question

PA5.

LO 11.4Falkland, Inc., is considering the purchase of a patent that has a cost of $50,000 and an estimated revenue producing life of 4 years. Falkland has a cost of capital of 8%. The patent is expected to generate the following amounts of annual income and cash flows:

Net income Operating cash flows Year 1 $ 5,100 17,050 Year 2 $ 6,500 18,450 Year 3 $ 6,300 18,250 Year 4 $ 3,000 14,850

1. What is the NPV of the investment?
2. What happens if the required rate of return increases?

Answer 1

	Year	Net Cash Flows	Discount Factor @ 8%	Present Value
	1	17,600	0.93	16,296
	2	19,000	0.86	16,289
	3	18,800	0.79	14,924
	4	15,500	0.74	11,393
			Present Value of Cash InFlows	58,903
			Less: Cash Ouflow	50,000
			NPV	8,903
	Working Note:
	Year	Net Income	Add Amortization (Non Cash)	Net Cash Flows
	1	5,100	12500	17,600
	2	6,500	12500	19,000
	3	6,300	12500	18,800
	4	3,000	12500	15,500
	As the Required Rate of Return Increase NPV will decease