Question

Assume that you are looking at an investment opportunity that offers an annual operating cash flow of $40,000 per year for 4 years. The initial investment to purchase the necessary equipment is $200,000. You assume that you can sell the equipment at the end of 4 years for $70,000. Also, there is a need for an investment in net working capital of $15,000. If the required rate of return is 5%, and the tax rate is 35%, would you accept this project? Multiple Choice Yes, because the NPV is $3,230,00 Yes, because the NPV is $23,338.48 Yes, because the NPV is $5,500.15 No, because the NPV is $3,230.24

Answer 1

Answer: Option-(d): No, because NPV is -$3,230.24 [Negative NPV implies that the investment is not capable of recovering all its cash outflows within its economic life. So, investment shall be rejected] Workings: 5% Annual discount rate, RATE Project's economic life, NPER Annual after-tax cash flows, PMT Salvage value & Working capital recovery at the end, FV Annual discount type, TYPE Present value of future cash flows Less: Cash outlay in year-o including working capital Net Present Value (NPV) $40,000 [As annual operating cash flow is directly given, tax effect is not given on such annual operating cash flows] $85,000 ($70,000 + $15,000 --> As depreciation related data are not given, salvage value is considered as after-tax cash inflow] 0 = 0 if discounted at the end of each period; 1 if discounted at the beginning of each period. $211,767.73 [Ref: NOTE] $215,000.00 [$200,000+ $15,000 --> Cost of investment + Working capital investment] $3,232.27 NOTE: Present value of future cash flows is calculated using EXCEL FUNCTION PV(rate,nper,pmt,fv,type) where rate=5%; nper=4; pmt=-40000; fv=-85000; type=0; Here, pmt & fv are negative as they they denote cash inflows; type=0 as cash flows are discounted at the end of each year only. E F G H 5% W А 1 Annual discount rate, RATE 2 Project's economic life, NPER 3 Annual after-tax cash flows, PMT 4 Salvage value & Working capital recovery at the end, FV 5 Annual discount type, TYPE Present value of future cash flows 7 Less: Cash outlay in year-O including working capital 8 Net Present Value (NPV) $40,000 [As annual operating cash flow is directly given, tax effect is not given on such annual operating cash flows] =70000+15000 $70,000+ $15,000 --> As depreciation related data are not given, salvage value is considered as after-tax cash inflow] 0 = 0 if discounted at the end of each period; 1 if discounted at the beginning of each period. =PV(B1,B2,-B3,-B4,B5) [Ref: NOTE] $215,000.00 ($200,000 + $15,000 --> Cost of investment + Working capital investment] =SUM(B6:B7) 600