Final answer:
To calculate the NPV of a project, compute the present value of each yearly cash inflow using the cost of capital and sum them up, then subtract the initial investment. This involves using the PV = Cash Inflow / (1 + Cost of Capital)^n formula for each year's inflow.
Step-by-step explanation:
To calculate the net present value (NPV) of a project with an initial cost of $340,000 and cash inflows of $94,000 at the end of each of the next 6 years at a cost of capital of 7%, the present value (PV) of each cash inflow needs to be calculated and summed up, and then the initial investment must be subtracted from this sum. To find the PV of each yearly inflow, a formula similar to the one shown in Table C2 is used: PV = Cash Inflow / (1 + Cost of Capital)n, where n is the year in which the cash is received.
For example, the first year's cash inflow would be calculated as $94,000 / (1 + 0.07)1, the second year's would be $94,000 / (1 + 0.07)2, and this is continued for all 6 years. Once all yearly present values are calculated, they are added together. The NPV of the project is then this total minus the initial cost of $340,000. The decision rule for NPV is that if it's positive, the project should be considered as it's expected to generate profit over the cost of capital.