Question

Quillen Company is performing a post-audit of a project completed one year ago. The initial estimates were that the project would cost $245,000, would have a useful life of 9 years, zero salvage value, and would result in net annual cash flows of $43,300 per year. Now that the investment has been in operation for 1 year, revised figures indicate that it actually cost $253,000, will have a total useful life of 11 years (including the year just completed), and will produce net annual cash flows of $36,500 per year. Click here to view PV table. Evaluate the success of the project. Assume a discount rate of 9%

Answer 1

We can use the net present value (NPV) method to assess the project's success because it takes the time value of money into account by reducing future cash flows to their present value.

Step-by-step explanation:

Let's first determine the project's initial estimated net present value (NPV) based on the preliminary estimates:

Initial anticipated cash flows: Year 0's initial cost is $245,000.

Net annual cash flows ($43,300) for Years 1 through 9.

The present value (PV) of the cash flows can be determined using a discount rate of 9% as follows:

PV of the net annual cash flows (Years 1–9): PV = $43,300 * [(1 - (1 + 0.09–-9) / 0.09] = $313,471.92.

Let's now determine the project's updated NPV based on the actual numbers:

Revised cash flows: Year 0's revised cost is -$253,000.

(Years 1 through 11) Net Annual Cash Flows: $36,500

PV of net annual cash flows (Years 1–11): PV = $36,500 * [(1–1+0.09)–1–1+0.09)–1–1+0.09)/0.09] = $317,534.54

The initial cost is subtracted from the present value of the cash flows to determine the NPV:

Initial estimated net present value (NPV): $313,471.92 - $245,000 = $68,471.92

NPV adjusted: $317,534.54 - $253,000 = $64,534.54.

The updated NPV ($64,534.54) is less than the first projected NPV ($68,471.92), as can be seen by comparing the two NPV numbers. Based on the updated numbers, this implies that the project's success has diminished. The initiative is producing less money than was initially projected.

It's vital to remember that NPV is only one indicator of a project's success; for a thorough analysis, other elements like the payback period and internal rate of return should also be taken into account.