Question

The owners of a chain of fast-food restaurants spend $25 million installing donut makers in all their restaurants. This is expected to increase cash flows by $11 million per year for the next five years. If the discount rate is 5.8%, were the owners correct in making the decision to install donut makers? A. No, as it has a net present value (NPV) of $4 million. B. Yes, as it has a net present value (NPV) of $22 million. C. No, as it has a net present value (NPV) of - $2 million. OD. Yes, as it has a net present value (NPV) of $13 million.

Answer 1

Pls find below steps, workings and answer:

B; Yes, As it has a net present value (NPV) of $ 22 million

0 1 2 3 4 5 -25 YEAR Investment Cost Free Cash Flows Total Cash Flows 11 11 11 11 11 -25 11 11 11 11 11 Discounting Factor 5.8% 1 3 4 YEAR Discounting Factor 0 1.0000 2 0.8934 5 0.7543 0.9452 0.8444 0.7981 Discounted Cash Flows -25 10 10 9 9 8 NPV 22 NPV

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;