Question

b) Using the tables provided in Appendix A, if you would like to receive $1,000 per year for the next five years, how much would you have to invest today, assuming 6% interest. LO3. How do discounted cash flow methods work? a) ABC Company is considering a project with an initial investment of $600,000 that is expected to produce cash inflows of $100,000 per year for 5 years. The required rate of return is 14%. i) What is the NPV of the project? Based on your answer, should ABC Company invest in this project?

Answer 1

Solution Part a: Computation of NPV of the project Initial investment $600,000 Annual Cash inflows $100,000 Life of project 5 Years Required rate of return 14% Present value annuity factor @ 14% for 5 Years 3.433 Annual Cash inflows $100,000 Present value of annual Cash inflows ($100,000 x 3.433) $343,300 Initial investment $600,000 Net Present value ($256,700) NPV of the project ($256,700) Should ABC Company invest in this project? The NPV of the project is negative, which indicates that the project will not provide required rate of return on the investment. Hence ABC Company should not invest in this project. Part b: Computation of amount to invest today to receive annuity of $1,000 Annual annuity to be receive Period $1,000 5 Years Interest rate 6% Present value annuity factor @ 6% for 5 Years 4.212 Amount to invest today to receive annuity ($1,000 x 4.212) $4,212 Amount to invest $4,212 Note: Present value annuity factor is rounded off upto 3 decimal points.