44. (8 points) A project is expected to have the following cash flows (at the en

Question

44. (8 points) A project is expected to have the following cash flows (at the end of each year): (Year, Cash Flow)....

0 = (500,000)

1 = 25,000

2 = 50,000

3 = 100,000

4 = 125,000

5 = 150,000

In addition, the project will have a residual value at the end of year 5 of 2 times year 5 cash flow. Assuming a discount rate of 10%:

a. What is the net present value of this project?

b. Would you recommend proceeding on this basis?

c. Would you still recommend proceeding if the project residual value at the end of year 5 is 1.5 times year 5?

Explanation / Answer

A)Residual Value = $150,000 x 2 = $300,000

NPV = -$500,000 + [($25,000)/(1.10)] + [($50,000)/(1.10)2] + [($100,000)/(1.10)3] + [($125,000)/(1.10)4] + [($150,000)/(1.10)5] + [($300,000)/(1.10)5]= $3,972.34

B)As the NPV is positive, we should accept the project

C) Residual Value = $150,000

NPV = -$500,000 + [($25,000)/(1.10)] + [($50,000)/(1.10)2] + [($100,000)/(1.10)3] + [($125,000)/(1.10)4] + [($150,000)/(1.10)5] + [($150,000)/(1.10)5]= -$89,165.85

With residual value of $150,000, NPV turns out to be negative, so we should reject this project in this scenario.

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