Question

Star City is considering an investment in the community center that is expected to return the following cash flows. Use Exhibit A.8.

Year	Net Cash Flow
1	$	37,000
2		67,000
3		97,000
4		97,000
5		117,000

This schedule includes all cash inflows from the project, which will also require an immediate $217,000 cash outlay. The city is tax-exempt; therefore, taxes need not be considered.

Required:

a. What is the net present value of the project if the appropriate discount rate is 26 percent?

b. What is the net present value of the project if the appropriate discount rate is 10 percent?

Answer 1

Net present value if difference between initial outal and present value of cash flow.

we will use discount factors to find present value of cash flow.

1. r=26%

Year	Cashflow	Discount factors at 26%	Present value of cash flows
0	($217,000)	1	($217,000)
1	$37,000	0.794	$29,378[$37,000*0.794]
2	$67,000	0.630	$42,210[$67,000*0.630]
3	$97,000	0.500	$48,500[$97,000*0.500]
4	$97,000	0.397	$38,509[$97,000*0.397]
5	$117,000	0.315	$36,855[$117,000*0.315]
		NPV	-$21,458[-$217,000+$29,378+42,210+48,500+38,509+36,855]

NPV is negative so invetsment should not be accepted at 26%

2. r= 10%

Year	Cashflow	Discount factors at 10%	Present value of cash flows
0	($217,000)	1	($217,000)
1	$37,000	0.909	$33,633[$37,000*0.909]
2	$67,000	0.826	$55,342[$67,000*0.826]
3	$97,000	0.751	$72,847[$97,000*0.751]
4	$97,000	0.683	$66,251[$97,000*0.683]
5	$117,000	0.621	$72,657[$117,000*0.621]
		NPV	$83,730 [-217,000+$33,633+72,847+66,251+72,657]

NPV is positive so Investment should be accepted at 10%

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