To decide if the firm should make the investment, calculate the net present value (NPV) of the project by subtracting the initial investment from the present value of the cash inflows. With a required rate of return of 8%, the NPV is positive, indicating that the firm should make the investment. The expected return is $106,538.76.
To decide whether the firm should make the investment, we need to calculate the net present value (NPV) of the project. The NPV is calculated by subtracting the initial investment from the present value of the cash inflows. Since the firm has the cash and doesn't need to borrow, the cost of capital can be ignored. Using the required rate of return of 8%, we can calculate the present value of the cash inflows in each year:
- Year 1: $50,000 / (1+0.08)^1 = $46,296.30
- Year 2: $60,000 / (1+0.08)^2 = $52,886.79
- Year 3: $70,000 / (1+0.08)^3 = $57,355.67
Then, we sum up the present values of the cash inflows:
$46,296.30 + $52,886.79 + $57,355.67 = $156,538.76
Finally, we subtract the initial investment of $50,000 from the sum of the present values:
$156,538.76 - $50,000 = $106,538.76
The NPV of the project is positive, which means that the firm should make the investment. It is expected to generate a positive return of $106,538.76.