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 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively.

Time:0 1 2 3 4 5 6

Cash flow:–$5,000 $1,200 $2,400 $1,600 $1,600 $1,400 $1,200

Use the NPV decision rule to evaluate this project. (find $ not years)

Can you give step by step instructions?

Answer 1

Evaluation of Investment proposal using NPV Decision Rule

Here, the Investment Decision can be taken based on the Net Present Value (NPV) of the Project, The Project should be accepted if the NPV is Positive, else, Reject the Project

Net Present Value (NPV) of the Project

Year	Annual Cash Inflow ($)	Present Value factor at 8%	Present Value of Annual Cash Inflow ($)
1	1,200	0.925926	1,111.11
2	2,400	0.857339	2,057.61
3	1,600	0.793832	1,270.13
4	1,600	0.735030	1,176.05
5	1,400	0.680583	952.82
6	1,200	0.630170	756.20
TOTAL			7,323.92

Net Present Value = Present value of annual cash inflows – Initial investment cost

= $7,323.92 - $5,000

= $2,323.92

DECISION

"YES, The Investment project should be accepted, since the Net Present Value (NPV) of the Project is Positive $2,323.92 and therefore, this is an acceptable project.

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)ⁿ], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.