Suppose that an existing machine generates a monthly cash flow of $150,000. An investment of $6,000,000...

Suppose that an existing machine generates a monthly cash flow
of $150,000. An investment of $6,000,000 will increase the cash
flow to $200,000 per month. The relevant monthly discount rate is1%. Should you invest?
• Let’s use the incremental method:
                        Period 0.                   Periods 1…
• Project 1.     0.                                 150,000
• Project 2.     -6,000,000                  200,000
Diff 2-1.          -6,000,000.                   50,000

Incremental NPV = -6000000+ 50000/0.01= -$1,000,000

how come incremental NPV uses 1% rather than (1+r)

Solutions

Expert Solution

As the cash flows are perpetual i.e., permanent or continue indefinitely

We have to use the formula for present value of perpetuity=monthly cash flows/monthly discount rate

Hence, it is 1% or 0.01 and not 1+1% or 1.01

jeff jeffy answered 2 years ago

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