Question

2. An investment requires an initial capital outlay of $12,000. The investment is expected to generate future cash flows of $1,000 one year hence, $2000 two years hence, $3,000 three years hence, $4,000 four years hence, $5,000 five years hence. Assume a 10% cost of capital.

This is the homework question but I think its asking for net present value?

Answer 1

Net Present value (NPV) is the present value of future cash inflows minus the initial investment

For calculating the present value of cash flows, we will use the present value of $1 table and find the present value of $1 for different years at 10%.

Present value at 10%:

Present value of future cash flows = $1000 * PV (10%, 1 Year) + $2000 * PV (10%, 2 Years) + $3000 * PV (10%, 3 Years) + $4000 * PV (10%, 4 Years) + $5000 * PV (10%, 5 years)

where, PV (10%, n years) is the present value of $1 at 10% for n years.

Now, putting the values from the present value table in the above equation, we get,

Present value of future cash flows = ($1000 * 0.909) + ($2000 * 0.826) + ($3000 * 0.751) + ($4000 * 0.683) + ($5000 * 0.621)

Present value of future cash flows = $909 + $1652 + $2253 + $2732 + $3105 = $10651

Initial investment (given) = $12000

Net Present value (NPV) = Present value of future cash inflows - initial investment

Net Present value (NPV) = $10651 - $12000 = - $1349