Question

Part Two Net Present Value Method Net present value (NPV) is one method that can be used to evaluate the fihancial viability of potential projects. It determines the present value of all future cash flows associated with potential projects and measures this against the cost of the project. To use net present value, a required rate of return must be defined. The required rate of return is the minimum acceptable rate of return that an investment must yield for it to make sense economically. Managers often choose a required rate of return above their cost of capital to ensure that the inherent uncertainties surrounding future cash flows is addressed. This can be risky, however, as it biases the process toward short-term projects. If the NPV is positive, then the project should be accepted ; if it is negative, then the project should be rejected Let's look at a net present value example using the present value of an ordinary annuity table. The company has a project with a 5-year life that requires an initial investment of $210,000, and is expected to yield annual cash flows of $64,000. What is the net present value of the project if the required rate of return is set at 12%? Calculation Steps Present Value of an Annuity of $1 at Compound Interest. Net Present Value = ($ Note: Round your answer to the nearest whole dollar. What NPV does the previous calculation yield? $ Based on the NPV computed above, what is indicated? 1. The project is profitable Check My Work Next >

Answer 1

Part Two Determination of Net Present Value (NPV): Initial Investment $ 210,000 Annual Cash Inflows $ 64,000 Project Life 5 Years Discount Rate 12% Present Value of Annuity Factor 3.6048 Net Present Value ($ 64,000 * 3.6048) - $ 210,000 $ 20,707.20 Part Three Determination of Present Value Index: Initial Investment $ 220,000 Annual Cash Inflows $ 56,500 Project Life 5 Years Discount Rate 10% Present Value of Annuity Factor 3.7908 Total Present Value of Net Cash Flows ($ 56,500 * 3.7908) $ 214,180 Present Value Index = Total Present Value of Net Cash Flows / Initial Investment Present Value Index = $ 214,180 / $ 220,000 Present Value Index = 0.97 Determination of IRR: Initial Investment $ 196,400 Annual Cash Inflows $ 58,000 Project Life 4 Years IRR = Investment / Annual Cash Flow IRR Factor = $ 196,400 / $ 58,000 IRR Factor = 3.386207 The calculated factor corresponds to which 7% (approx) in the present value of ordinary annuity table