Question

Square Manufacturing is considering investing in a robotics manufacturing line. Installation of the line will cost an estimated $10.5 million. This amount must be paid immediately even though construction will take three years to complete (years 0, 1, and 2). Year 3 will be spent testing the production line and, hence, it will not yield any positive cash flows. If the operation is very successful, the company can expect after-tax cash savings of $7.5 million per year in each of years 4 through 7. After reviewing the use of these systems with the management of other companies, Square’s controller has concluded that the operation will most probably result in annual savings of $4.9 million per year for each of years 4 through 7. However, it is entirely possible that the savings could be as low as $3.3 million per year for each of years 4 through 7. The company uses a 14 percent discount rate. Use Exhibit A.8.

Required:

Compute the NPV under the three scenarios. (Round PV factor to 3 decimal places. Enter your answers in thousands of dollars. Negative amounts should be indicated by a minus sign.)

	Best Case	Expected	Worst Case
Net present value

Answer 1

Net present value
It is a tool used to assess the viability of the project in terms of cash positive of cash negative outcome
If a project has +ve NPV, the project should be taken up and vice-versa.
The NPV is calculated by discounting cash flows of the project as per either cost of capital or expected rate of return.
In the given question discount rate to be used is 14%
The present value (PV) table for 14% and calculation is as follows:
Year	Calculation	PV factor
0	At year 0 PV is always 1	1.000
1	=1/(1.14)	0.877
2	=1/(1.14)^2	0.769
3	=1/(1.14)^3	0.675
4	=1/(1.14)^4	0.592
5	=1/(1.14)^5	0.519
6	=1/(1.14)^6	0.455
7	=1/(1.14)^7	0.399
For calculating NPV, each each cash flow is to be multiplied with relevant PV factor and all the values summed of together shall provide NPV of the project

Calculation of net present value of projects
The cash outflow, in each case, will be at year 0, i.e., at the start of the project and all cash inflows will start at year 4
														($ in '000)
Year (A)	PV factor (B)	Best case		Expected		Worst case
		Cash flow (C)	Pesent value (D=B*C)	Cash flow (E)	Pesent value (F=B*E)	Cash flow (G)	Pesent value (H=B*G)
								0	1.000	-10,500	-10,500	-10,500	-10,500	-10,500	-10,500
1	0.877	-	-	-	-	-	-
2	0.769	-	-	-	-	-	-
3	0.675	-	-	-	-	-	-
4	0.592	7,500	4,440	4,900	2,901	3,300	1,954
5	0.519	7,500	3,893	4,900	2,543	3,300	1,713
6	0.455	7,500	3,413	4,900	2,230	3,300	1,502
7	0.399	7,500	2,993	4,900	1,955	3,300	1,317
NPV			4,239		-871		-4,014
		Best case		Expected		Worst case
NPV ($ in '000)		4239		-871		-4014