Question

NPV and maximum return   

A firm can purchase new equipment for a ​$150,000 initial investment. The equipment generates an annual​ after-tax cash inflow of ​$44,400 for 4 years.

a. Determine the net present value

​ (NPV​)

of the​ asset, assuming that the firm has a cost of capital of

10​%.

Is the project​ acceptable?

b. Determine the maximum required rate of return that the firm can have and still accept the asset.

Answer 1

a. In order to determine the NPV of the project we need to discount the following cash flows wit the Cost of the capital

Cost of capital =10%

NPV = - INITIAL INV +C1/(1+R)^1 + C2/(1+R)^2……. C4/(1+R)^4

Initial Inv	0	-150000
CF1	1	44400
CF2	2	44400
CF3	3	44400
CF4	4	44400

NPV = - 150,000 +44,400/(1+0.10)^1 + 44,400/(1+0.1)^2+ 44,400/(1+0.10)^3 + 44,400/(1+0.1)^4

NPV = -9257.57

B The project is only profitable and acceptable if the NPV of the project is positive. In this case we can see the NPV of the project at 10% cost of capital is Negative

Hence the project is Not Acceptable

C The maxim required rate of return at which the company will till accept is the , IRR of the project

Internal rate of return is calculated as

- INITIAL INV +C1/(1+R)^1 + C2/(1+R)^2……. C4/(1+R)^4 =0

 

- 150,000 +44,400/(1+0.r)^1 + 44,400/(1+r)^2+ 44,400/(1+r)^3 + 44,400/(1+r)^4 = 0

Interpolating between r=7% and r = 7.25%

We get

IRR Of the project is 7.12%

Hence it is 7.12% the maximum rate at which the company can still accept the project