Question

Part A: Explain how Net Present Value (NPV) is used in evaluating capital budgeting proposals.

Part B: Imagine that you are given a $12,000 entrance scholarship to study at Brock University. Fortunately, over the years your parents have managed to save for your education through the purchase of an RESP. Therefore, you are able to invest the $12,000 for the next four years at an interest rate of 5%. How much money will you have after four years of investing the $12,000? In other words, what is the future value of $12, 000 invested over four years at a 5% interest rate? Be sure to show your calculations. In your response, be sure to incorporate properly the terms: Time Value of Money and Compounding. Lastly, using the Rule of 72, how many years will it take to double the initial investment?

Part C: Now that the IOC has made the decision to postpone the Tokyo Summer 2020 Olympics until next year, one of the sponsoring organizations finds itself with Olympic merchandise that needs to be liquidated. When you heard about this opportunity you became quite excited because you are an avid collector of Olympic merchandise. In fact, when you graduate from Brock University, you plan on opening an Olympic memorabilia shop. The offer from this Olympic sponsor is such that you have the option to purchase the merchandise entirely upfront for $10,500 or to pay $2,750 per year for the next four years (with payments at the beginning of the year). Assuming a discount rate of 7%, is it advisable to pay the cost of the merchandise entirely upfront? Explain. Be sure to show your calculations.

Answer 1

PART A)

Net present value (NPV) is used to determine the current value of all future cash flows generated by a project, including the initial capital investment. It is widely used in capital budgeting to establish which projects are likely to turn the greatest profit. NPV is used in capital budgeting to compare projects based on their expected rates of return, required investment, and anticipated revenue over time. Net present value discounts all the future cash flows from a project and subtracts its required investment. The analysis is used in capital budgeting to determine if a project should be undertaken when compared to alternative uses of capital or other projects.

PART B)

Future value of investment is $14586

Amount will be doubled in 18 years

C) The NPV of future cash fows of $ 2750 per year discounted at the rate of 7% is $ 9315. If this is compared with the upfront payment of $10500 their could be a possible savings of $ 1185. Hence it is not recommeded to make upfront payment.