Question

1. 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?

2. Determine the economic life for the asset.

3. What is the meaning of the result in b?

Answer 1

(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.