Leo company is considering a new venture in office equipment. It expects the cos
ID: 2619816 • Letter: L
Question
Leo company is considering a new venture in office equipment. It expects the cost of acquisition of land and building to be $100,000. Leo company expects cash flows to be $40,000 the first year and $45,000 for the next 4 years. It will discontinue the furniture operation upon the completions of the 5th year. Assume no salvage value. The company’s WACC is 10%.
What is Leo company’s NPV and should they accept or reject the project? Assume no other projects exist and that NPV should be used to make the decision.
A. $75,120; accept project
B. $66,040; accept project
C. $80,230; accept project
D. $(8,090); reject project
E. $(9,324); reject project
Explanation / Answer
Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)
=40000/1.1+45000/1.1^2+45000/1.1^3+45000/1.1^4+45000/1.1^5
=(40000/1.1)+45000[1/1.1^2+1/1.1^3+1/1.1^4+1/1.1^5]
(40000*0.9090909)+(45000*2.88169586)
=$166039.9501(Approx)
NPV=Present value of inflows-Present value of outflows
=$166039.9501-$100,000
=$66040(Approx)
Hence since NPV is positive;project must be accepted.
Hence the correct option is B.
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