Question

Acme corporation is considering a project to make gizmos. The cash flow would be $425,000 per year. The project cost is $2.6 million and no matter when the project is started, gizmos would become obsolete in 10 years.

However, the technology to produce gizmos is becoming cheaper by the year and the project costs are likely to decline by $230,000 per year until it reaches $1.45 million, after which there would be no more reduction in the project cost, Acme’s required return is 12 percent. Should the project be undertaken and if so, when?

Answer 1

Cash Inflow from the project = $425,000

Project Life = 10 years

Present Value of Cash Inflows when the project is started = 425,000*PVIFA(12%,10)

= 425,000*5.6502

= $2,401,335

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{1}	{2}	{3}	{4} = {2}-{3}	{5}	{6} = {4}*{5}
Year	Present Value of Cash Inflows	Initial Investment	NPV at the end of respective years	Discounting Factor @ 12%	Present Value of NPV at t = 0
0	2401335	2,600,000	(198,665)	1	(198,665)
1	2401335	2,370,000	31,335	0.8929	27,977.68
2	2401335	2,140,000	261,335	0.7972	208,334.66
3	2401335	1,910,000	491,335	0.7118	349,722.55
4	2401335	1,680,000	721,335	0.6355	458,421.43
5	2401335	1,450,000	951,335	0.5674	539,813.03

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Yes, Project should be undertaken.But it should be undertaken at the end of 5th year , where NPV is the highest in today's value.