You are evaluating a project which has a useful life of 5 years. However, you suspect that...

You are evaluating a project which has a useful life of 5 years. However, you suspect that the project’s economic life might be different. The initial investment for the project is $5,000,000. The cash flows for the 5 years are $5 million, $1.7 million, $1.8 million, $2 million, and $2 million. The abandonment value of the project in each of the first 4 years is $4.2 million, $4 million, $3.5 million, and $2 million. The abandonment value for the 5^th year is incorporated into the cash flow given above. The required rate for this project is 15%.
1. What is the NPV of the project, assuming its useful life?

Determine the economic life for the asset.

What is the meaning of the result in b?

Expert Solution

(a)

	Particulars	Cashflow	PVF @ 15%	Year 1	Year 2	Year 3	Year 4	Year 5
A	Initial Investment	($5,000,000)	1	($5,000,000)	($5,000,000)	($5,000,000)	($5,000,000)	($5,000,000)
	PV of Cash Outflows
B	Operational Cashinflows
	Year 1	$ 5,000,000	0.8696	$4,347,826	$4,347,826	$4,347,826	$4,347,826	$4,347,826
	Year 2	$ 1,700,000	0.7561		$ 1,285,444.23	$ 1,285,444.23	$ 1,285,444.23	$ 1,285,444.23
	Year 3	$ 1,800,000	0.6575			$ 1,183,529.22	$ 1,183,529.22	$ 1,183,529.22
	Year 4	$ 2,000,000	0.5718				$ 1,143,506.49	$ 1,143,506.49
	Year 5	$ 2,000,000	0.4972					$ 994,353.47
	PV of Cashinflows			$4,347,826	$5,633,270	$6,816,800	$7,960,306	$8,954,660

C	Abandonment Value
	Year 1	$ 4,200,000	0.8696	$ 3,652,173.91
	Year 2	$ 4,000,000	0.7561		$ 3,024,574.67
	Year 3	$ 3,500,000	0.6575			$ 2,301,306.81
	Year 4	$ 2,000,000	0.5718				$ 1,143,506.49
	Year 5	$ -	0.4972					$ -
	PV of Terminal Cash Inflows		$ 3,652,173.91	$ 3,024,574.67	$ 2,301,306.81	$ 1,143,506.49	$ -

D	NPV ((B+C)-A)			$ 3,000,000	$ 3,657,845	$ 4,118,106	$ 4,103,813	$ 3,954,660

E	PVAF			0.8696	1.6257	2.2832	2.8550	3.3522

F	Annualised NPV			$ 3,450,000	$ 2,250,000	$ 1,803,636	$ 1,437,423	$ 1,179,736

(b) As Annualised NPV of the aset is higher for Usage life of 1 Year, Economic life of th asset = 1Yeaarr.

(c) Economic Life means the time period with in which replacement of the asset is more benefecial.

jeff jeffy answered 2 years ago

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