Question

Should a company start a multi-year investment project? Here's what's known:

The return required for this project is 8.1% per year. $439,000 would need to be invested right away to buy all necessary production equipment. This project is expected to end at the end of Year 6, and at that time all production equipment will be sold and generate a cash inflow of $150,000 in after-tax salvage value. To meet any unforeseen equipment maintenance and repair expenses, $42,000 of cash would be set aside at the start of the project. The cash balance will then be recovered at the end of the project's life. $80,000 in after-tax profits (i.e., operating cash flow) is estimated for each future year of the project.
The project's Net Present Value equals $_______.

Answer 1

To decide on starting a multi-year investment project, the Net Present Value (NPV) is calculated by summing the present values of all estimated after-tax profits, salvage value, and recovered cash balances, discounted by the required return rate and subtracting the initial investment.

Step-by-step explanation:

To determine whether a company should start a multi-year investment project, we can calculate the Net Present Value (NPV). The calculation will take into account all cash inflows and outflows, discounting future cash flows at the required return rate. Initial investment includes equipment cost and setting aside cash for maintenance.

The cash flows for each year of the project consist of the annual after-tax profits, and at the end of the project, the recovery of the maintenance cash balance and equipment salvage value are included. By discounting these amounts at 8.1% per annum, we can find the present value of each cash flow.

NPV is then found by summing the present values of all cash flows and subtracting the initial investment. A positive NPV would suggest that the project should be accepted, while a negative NPV would suggest the opposite.