Question

An Electronics shop provides specialty-manufacturing service. The initial outlay is $30 million and, management estimates that the firm might generate cash flows for years one through five equal to $5,000,000;$7,500,000;$10,500,000; $20,000,000; and $20,000,000. The company uses a 20% discount rate for projects of this type. Is this a good investment opportunity? Explain your answer

Answer 1

The investment opportunity appears to be good based on a positive net present value (NPV) calculated from the cash flows generated by the specialty-manufacturing service.

Step-by-step explanation:

To determine whether the investment opportunity is good, we need to calculate the net present value (NPV) of the cash flows generated by the specialty-manufacturing service. NPV takes into account the initial outlay and the discounted cash flows over the years. We can use the formula:

NPV = -Initial Outlay + (Cash Flow1 / (1 + Discount Rate)^1) + (Cash Flow2 / (1 + Discount Rate)^2) + ...

Substituting the values into the formula:

NPV = -30,000,000 + (5,000,000 / (1 + 0.2)^1) + (7,500,000 / (1 + 0.2)^2) + (10,500,000 / (1 + 0.2)^3) + (20,000,000 / (1 + 0.2)^4) + (20,000,000 / (1 + 0.2)^5)

Calculating the NPV:

NPV = -30,000,000 + (5,000,000 / 1.2) + (7,500,000 / 1.44) + (10,500,000 / 1.728) + (20,000,000 / 2.0736) + (20,000,000 / 2.48832) = 14,864,530.56

Since the NPV is positive, this indicates that the investment opportunity is good. The positive NPV suggests that the cash flows generated by the specialty-manufacturing service are expected to exceed the initial outlay and provide a return on investment.