Question

Balon Enterprises is looking to invest in a new product to extend their operations. The new project is expected to require an initial cash investment of $350,000 plus additional working capital of $50,000 will be required and this will be recovered at the end of year 6. At the end of the project the initial investment will have an expected salvage value of $0.
Cash inflows of $100,000 are expected at the end of each year for 5 years and then in year 6 the inflows are expected to drop off to $30,000. The company’s required rate of return of any project is 12%.

Assume cash returns occur at the end of each year apart from the initial investment.

Use the required rate of return as the discount rate and use the tables at the back of this booklet to find the discount rates.
Ignore tax.

(a) Conduct a net present value analysis for the new project. Show your workings.

(b) Based on the NPV analysis, state whether Balon Enterprises should invest in this new project and explain why.

(c) The Chief Financial Officer is concerned that the effects of COVID19 will mean that the forecasted cash inflows will only be $80,000 each year for years 1 to 5 and all other cash flows remain the same. Describe the effect of this change in estimate on the NPV. No calculation is required.

Answer 1

the net present value of the project

YEAR	CASH INFLOW	DF @ 12%	PRESENT VALUE OF INFLOW
1	100000	0.893	89300
2	100000	0.797	79700
3	100000	0.712	71200
4	100000	0.635	63500
5	100000	0.567	567010
6	(30000+50000)80000	0.507	40560
			400960

a) the present value of the project 400960

b) initial investment = 400000(350000+50000)

the net present value of the project =prsent value of cash inflows-initial investment

4,00,960-4,00,000=960.

the investor who is looking to invest can invest because the present value is positive, which indicates the project is above the initial investment. and the profit of the project will be $960

c)if the cash-flow is decreased to $80,000 due to COVID19, then it will definitely affect the outcome of net present value .there will not be any profit to cover the initial investment, therefore the company must not take this project to consideration.because the net present value outcome is giving a negative balance, under this scenario.