Question

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $580,000 per year. If the discount rate is 7.5%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship

Answer 1

$ 508304.93

Step-by-step explanation:

Using the formula for calculating the net present value

NPV = Cash flow / ( 1 + i)^n - initial investment

where NPV = net present value which represent the change in the value of the company

i = the discounted rate and n is the number of years

NPV = 580000 / (1 + 0.075)¹ + 580000 / (1 + 0.075)² + 580000 / (1 + 0.075)³ - 1 000 000 = 539534.88 + 501892.92 + 466877.13 - 1000000 = $ 508304.93 is the change in the value of the company.