Suppose your firm is considering investing in a project with the cash flows show

Question

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 13 percent, and that the maximum allowable payback and discounted payback statistics for your company are 2.5 and 3.0 years, respectively.

Use the NPV decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Time: 0 1 2 3 4 5 Cash flow: –$364,000 $64,900 $83,100 $140,100 $121,100 $80,300

Explanation / Answer

As the question requires evaluation based on NPV. Information on payback and discounted payback becomes unnecessary information.

CALCULATION OF NPV

Evaluation result : This project is not worth trying. The negative NPV indicates that present value of benefit is lower than present value of Investment. Acceptence of such a project shall destroy the wealth of shareholder.

Explanation

(1) DF = Discounting factors. They can be taken from standard Present value tables (or) we can try on the calculator......... (a) 1/1.13 and press "=" to get year - 1 discounting factor. There after just continue to press "=" to get the subsequent years DF values.

(2) PV = Present value of cash flow = Cash flow * DF

Time Cash flow DF PV 0 -364000 1 -364000 1 64900 0.884956 57433.63 2 83100 0.783147 65079.49 3 140100 0.69305 97096.33 4 121100 0.613319 74272.9 5 80300 0.54276 43583.62 NPV -26534

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