Question

Suppose Cold Goose Metal Works Inc. is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $3,000,000. The project is expected to generate the following net cash flows:

Year Cash Flow
Year 1 $350,000
Year 2 $450,000
Year 3 $450,000
Year 4 $450,000

Cold Goose Metal Works Inc.'s weighted average cost of capital is 8%, and project Beta has the same risk as the firm's average project. Based on the cash flows, what is project Beta's NPV?

Answer 1

Cold Goose Metal Works Inc.

Based on the cash flows, project Beta's NPV is negative:

= ($1,602,200).

Step-by-step explanation:

a) Data and Calculations:

Initial investment in project Beta = $3,000,000

Weighted average cost of capital = 8%

Net cash flows:

Year Cash Flow Discount Factor Present Value

Year 1 $350,000 0.926 $324,100

Year 2 $450,000 0.857 385,650

Year 3 $450,000 0.794 357,300

Year 4 $450,000 0.735 330,750

Total cash inflows = $1,397,800

Investment cost = $3,000,000

NPV = -$1,602,200

b) Cold Goose should not pursue the investment. The cash outflows outweigh the cash inflows by more than 50%. The net present value of the project is negative.