1. A firm has the opportunity to invest in a project that is expected to pay an
ID: 2705113 • Letter: 1
Question
1. A firm has the opportunity to invest in a project that is expected to pay an end-of-year annual return of $1.5 million for each of the next twenty years after taxes and expenses. The current cost of the project would be $7 million. Assuming a discount rate of 12%, as the required rate of return and (opportunity) cost of capital
(i.e., economic costs of capital): (a) Calculate the present value of the project to the firm. (b) Calculate the net present value of the project. (c) Using the net present value principle, determine whether or not the firm should make the investment. (d) Using the internal rate of return principle, determine whether or not the firm should make the investment. (e) Using the equilibrium market value of the firm principle, determine whether or not the value of the firm would increase if the firm decided to undertake this investment project. PLEASE SHOW WORK
Explanation / Answer
(a) present value of the project to the firm= 1.5million x PVIFA(12%,20)= $1.5mx7.469= $11204165.44
(b) net present value of the project= -7million+11204165.44= 4204165.437
(c) Since the NPV of the project is positive, the firm should make the investment.
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