Question

Please show full work if possible, would like to be able to understand the problem and solution.

Leo company is considering a new venture in office equipment. It expects the cost of

acquisition of land and building to be $100,000. Leo company expects cash flows to be $40,000

the first year and $45,000 for the next 4 years. It will discontinue the furniture operation upon

the completions of the 5th year. Assume no salvage value. The company’s WACC is 10%.

6. What is Leo company’s NPV and should they accept or reject the project? Assume no other

projects exist and that NPV should be used to make the decision.

A. $75,120; accept project

B. $66,040; accept project

C. $80,230; accept project

D. $(8,090); reject project

E. $(9,324); reject project

Answer 1

NPV = Difference between Present value of inflow and Present value of Outflow

Outflows here is only $100,000 which is to be incurred in the present year itself.

Inflows are $40,000 in year one and $45,000 from year 2 to year 5. These Inflows are future cash flows. We will have to discount this to the Present value. As The WACC is 10%,We have to discount the cash Inflows using the Present Value Factor(PV Facor) from the values given in the PV Table for 10%.

We can create a following table for solving the problem

Year	Discounting	Cash Flow	Discounted
	Factor @10%		cashflow
0	-1	100000	-100000
1	0.909091	40000	36364
2	0.826446	45000	37190
3	0.751315	45000	33809
4	0.683013	45000	30736
5	0.620921	45000	27941
			66040

We have a positive NPV of 66040, So we have to accept the project

In year 0 which is the current year we are having an outflow.so the discounting factor or the PV factor has to be taken as -1. All other are inflows. So the net resultis $66040,

Note

Discounting means to find the present value of the cash inflows expected to arise in the future.