Question

1. the concept of net present value, and how it is calculated.

2. the net present value rule.

3. What do you understand by the concept 'internal rate of return'?

4. How is the net present value different from the internal rate of return?

5. A business proprietor sells on average $8000 worth of gasoline on rainy days and an average of $9500 on clear days. Statistics from the local meteorological station indicates that the probability is 0.76 for clear weather, and 0.24 for rainy weather on Sunday. Find the expected value of gasoline sales on Monday. Explain your calculations using one slide

Answer 1

1)Net present value (NPV) Is the difference between the present value of cash inlfow reduced by initial cash outfow.

Calculation of NPV - NPV=PV of cash inflow -initial outflow

Present value of cash inflow is obtained by discounting the cash inflow by a hurdle rate(usually the cost of capital) of the firm.

2)Net Present Rule is that the company/firm should undertake the project only if it has positive net present value.

3)Internal rate of return (IRR) is the rate of return actually earned by investing in the project.At IRR, Present value of cash inflow - initial outflow =0.

4)Net present value is calculated by discounting the cash flow at predefined rate (hurdle rate of firm/company).While calculating NPV,the company has certain expectation of return(hurdle rate of return).It undertakes the project only if achieves that return.

While internal rate of return is the return achieved by undertaking the project.

5)Expected value of sales= (prob of rainy weather*sales on rainy day)+(probof clear weather*sales on clear day)

Expected value of sales=(0.24*8000)+(0.76*9500)

Expected value of sales=1920+7220

Expected value of sales=$9140