Question

What is the NPV for the following project if its cost of capital is 12 percent and its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and ($1,300,000) in year 4?

A) $(1,494,336)
B) $1,494,336
C) Greater than zero
D) Two of the above

Answer 1

The NPV is the sum of the present values of future cash flows minus the initial investment. The present value of cash flows for each year are calculated and summed, resulting in a positive NPV. Therefore, the correct answer is (C) Greater than zero.

Step-by-step explanation:

The Net Present Value (NPV) is calculated by discounting the future cash flows back to their present value and then subtracting the initial investment. Since the cost of capital is 12%, we discount the cash flows using this rate. The cash flows are:

• $1,800,000 in year 1
• $1,900,000 in year 2
• $1,700,000 in year 3
• ($1,300,000) in year 4

First, we calculate the present value of each year's cash flow:

• Year 1: $1,800,000 / (1 + 0.12)1 = $1,607,143
• Year 2: $1,900,000 / (1 + 0.12)2 = $1,515,337
• Year 3: $1,700,000 / (1 + 0.12)3 = $1,214,408
• Year 4: ($1,300,000) / (1 + 0.12)4 = ($826,446)

Then, we sum these present values and subtract the initial cost:

NPV = $1,607,143 + $1,515,337 + $1,214,408 - $826,446 - $5,000,000 = $510,442

This NPV is positive, so the correct answer is (C) Greater than zero.