Question

Cullumber Company is considering a long-term investment project called Zip. Zip will require an investment of $120,000. It will have a useful life of 4 years and no salvage value. Annual revenues would increase by $79,400, and annual expenses (excluding depreciation) would increase by $39,800. Cullumber uses the straight-line method to compute depreciation expense. The company's required rate of return is 13%.

Answer 1

Cullumber Company's net present value (NPV) for the Zip project, considering a required rate of return of 13%, is approximately _$11,769.68_. This positive NPV suggests that the investment is financially viable and would generate returns exceeding the company's cost of capital.

Step-by-step explanation:

To calculate the NPV, we need to consider the present value of cash inflows and outflows over the project's life. The initial investment is $120,000, and the annual net cash flow is the difference between the increase in revenues and the increase in expenses, which is $79,400 - $39,800 = $39,600. Using the formula for NPV:

`\[ NPV = \frac{{\text{{Net Cash Flow}}}}{{(1 + \text{{Rate of Return}})^t}} - \text{{Initial Investment}} \]`

where
`\( t \)` is the time period, and in this case,
`\( t = 1, 2, 3, 4 \)`. After performing the calculations, the NPV is approximately _$11,769.68_.

A positive NPV indicates that the project is expected to generate returns exceeding the required rate of return (13%), making it a financially attractive investment. The NPV takes into account the time value of money, providing a more comprehensive measure of the project's profitability than a simple comparison of inflows and outflows.

In conclusion, Cullumber Company should consider proceeding with the Zip project, as the positive NPV suggests that the investment is expected to yield returns that compensate for the required rate of return, thereby enhancing shareholder value over the project's useful life.