Question

A company is considering a project with an initial investment of $80,000. The annual inflow from the project is $10,000 for ten years. The salvage value for the project is $12,000 in year ten. The cost of capital is 12%. Should the company make this investment?

Answer 1

Net Present Value (NPV) of the Investment

Period	Annual Cash Flow ($)	Present Value factor at 12%	Present Value of Cash Flow ($)
1	10,000	0.892857	8,928.57
2	10,000	0.797194	7,971.94
3	10,000	0.711780	7,117.80
4	10,000	0.635518	6,355.18
5	10,000	0.567427	5,674.27
6	10,000	0.506631	5,066.31
7	10,000	0.452349	4,523.49
8	10,000	0.403883	4,038.83
9	10,000	0.360610	3,606.10
10	22,000 [10,000 + 12,000]	0.321973	7,083.41
TOTAL			60,365.91

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $60,365.91 - $80,000

= -$19,634.09 (Negative NPV)

“The Net Present Value (NPV) of the Project will be -$19,634.09 (Negative NPV)”

DECISION

“NO”. As per NPV Decision Rule, the Project should be accepted only if the NPV is Positive, else, Reject the Project. Here, the NPV of the Project is Negative 19,634.09 and therefore, the company should not make this investment.

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.