The Blue Moon is considering a 4-year project that requires an investment of $2.

Question

The Blue Moon is considering a 4-year project that requires an investment of $2.8 million for new equipment. This equipment will be depreciated straight-line to zero over the life of the project and will be worthless thereafter. The project is expected to produce cash inflows of $1 million a year for 4 years. The firm’s WACC is 11.5 percent. Management uses the subjective approach for setting required returns for projects and has set the adjustment for this project at +1.5 percent. Should this project be accepted? Why or why not?

a. yes; The NPV is $174,471.33.

b. yes; The NPV is $269,613.80.

c. no; The NPV is -$11,408.19.

d. no; The NPV is -$128,358.58.

Explanation / Answer

a. yes; The NPV is $174,471.33. Statement showing Cash flows Particulars Time PVf@13% Amount PV Cash Outflows                               -                                           1.00        (2,800,000.00)                  (2,800,000.00) PV of Cash outflows                  (2,800,000.00) Cash inflows                         1.00                                    0.8850           1,000,000.00                        884,955.75 Cash inflows                         2.00                                    0.7831           1,000,000.00                        783,146.68 Cash inflows                         3.00                                    0.6931           1,000,000.00                        693,050.16 Cash inflows                         4.00                                    0.6133           1,000,000.00                        613,318.73 PV of Cash Inflows                    2,974,471.33 NPV                        174,471.33 PVF =11.5% + 1.5% = 13%

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