Fox Enterprises is considering expanding into the growing laser copier business.

Question

Fox Enterprises is considering expanding into the growing laser copier business. Fox estimates that this expansion will cost $1.8 million and will generate a 20 year stream of expected net cash flows amounting to $400,000 per year. The company's weighted cost of capital is 15%.

A. Compute the net present value of the laser copier project using the company's weighted cost of capital and the expected cash flows from the project.

B. Using the risk-adjusted discount rate approach, management has decided that this project has substantially more risk than average and has decided that it requires a 24 percent expected rate of return on projects like this. Recompute the risk-adjusted net present value of this project.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

NPV = -1800000 + 400000/(1+.15)^1 + 400000/(1+.15)^2 + 400000/(1+.15)^3 + 400000/(1+.15)^4 + 400000/(1+.15)^5 + 400000/(1+.15)^6 + 400000/(1+.15)^7 + 400000/(1+.15)^8 + 400000/(1+.15)^9 + 400000/(1+.15)^10 + 400000/(1+.15)^11 + 400000/(1+.15)^12 + 400000/(1+.15)^13 + 400000/(1+.15)^14 + 400000/(1+.15)^15 + 400000/(1+.15)^16 + 400000/(1+.15)^17 + 400000/(1+.15)^18 + 400000/(1+.15)^19 + 400000/(1+.15)^20 = 703732.59

Part B:

Risk Adjusted NPV = -1800000 + 400000/(1+.24)^1 + 400000/(1+.24)^2 + 400000/(1+.24)^3 + 400000/(1+.24)^4 + 400000/(1+.24)^5 + 400000/(1+.24)^6 + 400000/(1+.24)^7 + 400000/(1+.24)^8 + 400000/(1+.24)^9 + 400000/(1+.24)^10 + 400000/(1+.24)^11 + 400000/(1+.24)^12 + 400000/(1+.24)^13 + 400000/(1+.24)^14 + 400000/(1+.24)^15 + 400000/(1+.24)^16 + 400000/(1+.24)^17 + 400000/(1+.24)^18 + 400000/(1+.24)^19 + 400000/(1+.24)^20 = -155897.28

Thanks

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