Final answer:
Flower Power should invest in the project if the project's cost is less than or equal to $709,876.55. This is the maximum cost that will result in a non-negative net present value (NPV) using the company's required rate of return of 8% to discount the net cash flows of $320,000 in the first year and $480,000 in the second year.
Step-by-step explanation:
To determine whether Flower Power should invest in the project, we must calculate the project's net present value (NPV) using the company's required rate of return. The net present value method is crucial in capital budgeting decisions as it helps in assessing the profitability of an investment. The NPV calculates the value of cash flows by discounting them at the required rate of return, which represents the cost of capital for the company.
The required rate of return for Flower Power is 8%. To find out the maximum cost that makes the investment worthwhile, the NPV should be greater than or equal to zero. The estimated cash flows are $320,000 for the first year and $480,000 for the second year. We will discount these cash flows back to their present value using the formula PV = C / (1 + r)^n, where C is the cash flow, r is the discount rate, and n is the year number.
Present Value of first year's cash flow: PV = $320,000 / (1 + 0.08)^1 = $296,296.30
Present Value of second year's cash flow: PV = $480,000 / (1 + 0.08)^2 = $413,580.25
The total present value of the cash flows is the sum of the present values: $296,296.30 + $413,580.25 = $709,876.55. This is the value today of the cash flows that the project will generate. Therefore, Flower Power should invest in the project if its cost is less than or equal to $709,876.55.
It is important to note that the investment decision is contingent upon the cost of the project. If the actual cost of the project is more than $709,876.55, the company may not cover its cost of capital and, therefore, might decide against investing in it.