Question

Pena Company is considering an investment of $27,160 that provides net cash flows of $8,200 annually for four years.

If Penna Company requires a 6% return on its investment, what is the net present value of this investment?

Answer 1

To calculate the NPV of Pena Company's investment, the present value of the annual $8,200 cash flows must be computed for 4 years at a discount rate of 6%, summed up, and then the initial investment of $27,160 is subtracted from this sum. The investment is worth pursuing if the NPV is positive.

Step-by-step explanation:

To determine the net present value (NPV) of Pena Company's investment, we need to discount the future cash flows using the required rate of return, which is 6% in this case. The formula for NPV involves calculating the present value (PV) of each annual cash flow and then summing those values and subtracting the initial investment.

Here's how the calculation is done step-by-step:

1. Calculate the present value of each annual cash flow by dividing the cash flow by (1 + r)^n, where r is the discount rate (6%) and n is the year number.
2. Add the present values of all the cash flows to get the total PV of cash flows.
3. Subtract the initial investment from the total PV to get the NPV.

For Pena Company:

1. PV of cash flows for year 1 to 4: $8,200 / (1 + 0.06)^1 + $8,200 / (1 + 0.06)^2 + $8,200 / (1 + 0.06)^3 + $8,200 / (1 + 0.06)^4.
2. Total PV of cash flows: Sum of the PV from step 1.
3. NPV: Total PV - Initial Investment.

Calculating those values should provide the NPV which can then be assessed for profitability (if NPV > 0, the investment is considered profitable).