Question

1. A firm with a current value (cost) of $800 and will return $1,000 next year. The firm also has a potential project that costs $500 and will return $550 next year, but the firm does not have the money to invest and must raise it from outside investors. However, outside investors mistakenly believe the firm will be worth $820 in one year without the project and $13,030 with the project. For simplicity, assume a zero discount rate. Does the project have a positive NPV? Acting on behalf of existing shareholders, should you take the project?

Answer 1

A	B	C	D	E	F	G	H	I	J	K	L
2
3		NPV calculation:
4		NPV of the project is present value of future cash flows discounted at required rate of return less the initial investment.
5
6		Year	0	1
7		Free Cash Flow (FCF)	($500)	$550
8		Required rate of return (i)	0%
9		(P/F,i,n) for each year		1.00	=1/((1+$D8)^E6)
10		Present Value of cash flows = FCF*(P/F,i,n)		$550.00
11		Present value if future cash flows	$550.00	=SUM(E10:I10)
12
13		NPV for Project	=Present value fo future cash flows - Initial investment
14			=$550-$500
15			$50	=D11+D7
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17		Hence NPV of the project is	$50
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19		A project with positive NPV add value to the firm.
20		Since the NPV of the project is positive therefore the project should be accepted by the shareholders.
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