Question

Net present value: Gao Enterprises plans to build a new plant at a cost of 3,250,000. The plant is expected to generate annual cash flows of1,225,000 for the next five years. If the firm's required rate of return is 18 percent, what is the NPV of this project?

Answer 1

To calculate the NPV for Gao Enterprises' new plant project, the expected future cash flows are discounted to their present value using the required rate of return, and subsequently, the initial investment is subtracted from the total of these present values.

Step-by-step explanation:

The student has inquired about calculating the Net Present Value (NPV) for a new plant project undertaken by Gao Enterprises. With an initial investment costing $3,250,000 and expected annual cash flows of $1,225,000 for each of the next five years, alongside a required rate of return of 18%, the aim is to determine if this investment is worthwhile based on its NPV.

To calculate the NPV, one would discount the expected future cash flows back to their present value and then subtract the initial investment. The formula for NPV is as follows:

• NPV = (Present Value of Future Cash Flows) - (Initial Investment)

The present value of each cash flow is calculated using the formula:

Present Value = Future Cash Flow / (1 + r)^n

Where 'r' is the required rate of return and 'n' is the number of years in the future the cash flow will be received. This calculation is done for each year’s cash flow. Once all present values are obtained, they are summed, and the initial investment is subtracted to find the NPV.