Question

You are considering a project that will require an initial outlay of $54,200. This project has an expected lifeof 5 years and will generate free cash flows to the company as a whole of $20,608 at the end of each year over its 5-year life. In addition to the $20,608 cash flow from operations at the end of the fifth and final year, there will be an additional free cash inflow of $13,200 at the end of the fifth year associated with the salvage value of the machine, making the cash flow in year 5 equal to $33,808. Thus, the free cash flows associated with this project look like this:

REQUIRED:
1) Given a required rate of return of 15 percent, calculate the Net Present Value
2)Should this project be accepted? Justify.

YEAR FREE CASH FLOW YEAR FREE CASH FLOW -54,200 20,608 20,608 20,608 20,608 33.808

Answer 1

Solution:-

(1) NPV = -54,200*1 + 20,608*(1/1.15) + 20,608*(1/1.15)^{2 +} 20,608*(1/1.15)³ + 20,608*(1/1.15)⁴ + 33,808*(1/1.15)⁵

NPV = -54,200 + 20,608*0.870 + 20,608*0.756 ⁺ 20,608*0.658 + 20,608*0.572 + 33,808*0.497

NPV = $21,459.02

(2) Since the NPV is positive, it means that the project's return is more than 15%, hence the project should be accepted