A number of companies, including Litchfield Design and Oxygen Optimization, are

Question

A number of companies, including Litchfield Design and Oxygen Optimization, are considering undertaking project A, which is believed by all to have a level of risk that is equal to that of the average-risk project at Litchfield Design. Project A is a project that would require an initial investment of 6,374 dollars and then produce an expected cash flow of 12,675 dollars in 6 years. Project A has an internal rate of return of 12.139 percent. The weighted-average cost of capital for Litchfield Design is 11.38 percent and the weighted-average cost of capital for Oxygen Optimization is 13.37 percent. What is the NPV that Oxygen Optimization would compute for project A?

Explanation / Answer

Computation of NPV:

Net Present value(NPV) =Present value (P V) of Cash Inflows - Present values(P V) of Cash outflows

Internal Rate of return =12.139%

P V of Cash Outflows =$6374

Cash Inflows in 6 Years =$12675

Weighted average cost of capital =13.37%

Therefore,cost of capital for 6 years = $6374*13.37%*6=$5113.22

Net gain from investment in project A = 12675 - 5113.22 =$7561.78

If Oxyen Optimization invest $6374 in some other activity,it would have earned at Internal rate of return of 12.139% per annum.

Cash inflows from other activity = $6374*12.139%*6 = $4642.44

Net gain from investment in project is more than Cash inflows from internal rate of return,project A can be accepted by Oxygen Optimization.

NPV=P V of cash Inflows - P V of cash outflows

=$12675*PVIAF(12.139%,6years) - $6374

=$12675*4.095 -$6374

=$51907-$6374

=$45533.58

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.