Final answer:
Net Present Value (NPV) is calculated by discounting future cash flows to their present value using a specific discount rate and subtracting the initial investment. The cash flows of the investment for each year are discounted back to their present value and summed up; then, the initial investment is subtracted to determine the NPV.
Step-by-step explanation:
Net Present Value (NPV) is a financial metric used to evaluate the profitability of an investment. It involves calculating the present value of each future cash flow, discounted back to its value in current dollars using a specific discount rate, and then subtracting the initial outlay.
Calculating NPV:
To compute the NPV, you take the future cash inflows and outflows and discount them back to their present value using the discount rate. Here, the discount rate is 10%. Once you have the present values, add them up and subtract the initial outlay.
Here are the calculations for each year's present value:
- Yr.1 = $125 / (1 + 0.10)^1
- Yr.2 = $150 / (1 + 0.10)^2
- Yr.3 = $120 / (1 + 0.10)^3
- Yr.4 = $200 / (1 + 0.10)^4
- Yr.5 = $100 / (1 + 0.10)^5
After calculating each year's present value, they are summed and the initial investment of $428 is subtracted to find the NPV. This content loaded with the significance of NPV helps elucidate what the net present value of an investment is.