Question

A firm with yearly net income of $31,000 has only two customers, each of whom makes identical purchases once per year. Timely Tom makes his purchase today and at the start of next year, while Late Louie makes his purchase half a year from today and halfway into next year (18 months from today). Moreover, Late Louie always pays 6 months late, i.e. at year end. What is the NPV of all cash flows to this firm in the next two years? Assume a yearly discount rate of 5.5%. Note: Report answer to 4 decimal places, no rounding.

Answer 1

As the yearly net income of $31,000 is earned from only 2 customers, contribution of each customer to yearly net income = $31,000 / 2 =  $15,500  

Cash flows over the next 2 years are :

$15,500 today (from Timely Tom)

$15,500 at the start of next year (which is also the end of this year) - from Timely Tom

$15,500 at the end of this year (from Late Louie) - the purchase is made 6 months from now, but payment received only 1 year from now

$15,500 at the end of next year (from Late Louie) - the purchase is made 18 months from now, but payment received only 24 months from now

NPV of cash flows = sum of present values of all cash flows

NPV = $15,500 + ($15,500 / 1.055) + ($15,500 / 1.055) + ($15,500 / 1.055²)

NPV = $58,809.90