Final answer:
To calculate the NPV, discount the cash flows at the target rate of 15% and subtract the initial investment. With cash flows of $150 for the first two years and a final year cash flow of $3150, the total PV is $2443.73. Subtracting the initial investment yields an NPV of $443.73, indicating the company should invest.
Step-by-step explanation:
To calculate the net present value (NPV) of the project, we need to discount the expected cash flows back to their present value (PV) and then subtract the initial investment. The cash flows in the project are $150 for the first two years and $3150 ($150 + $3000) for the third year. We will use the target rate of return of 15% per annum to discount these cash flows.
Here's how to calculate the Present Value (PV) for each year:
- Year 1: $150 / (1 + 0.15)^1 = $130.43
- Year 2: $150 / (1 + 0.15)^2 = $113.42
- Year 3: $3150 / (1 + 0.15)^3 = $2199.88
Now, add up the PVs of all cash flows:
- Total PV = $130.43 + $113.42 + $2199.88 = $2443.73
Subtract the initial investment from the total PV to get the NPV:
- NPV = $2443.73 - $2000 = $443.73
Since the NPV is positive, it suggests that the company should invest in the project, as it is expected to generate a return that exceeds the target rate of return of 15%.