Question

Net Present Value

Use Exhibit 12B.1 and Exhibit 12B.2 to locate the present value of an annuity of $1, which is the amount to be multiplied times the future annual cash flow amount.

Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.

1. Campbell Manufacturing is considering the purchase of a new welding system. The cash benefits will be $480,000 per year. The system costs $2,850,000 and will last 10 years.
2. Evee Cardenas is interested in investing in a women's specialty shop. The cost of the investment is $180,000. She estimates that the return from owning her own shop will be $40,000 per year. She estimates that the shop will have a useful life of 6 years.
3. Barker Company calculated the NPV of a project and found it to be $63,900. The project's life was estimated to be 8 years. The required rate of return used for the NPV calculation was 10%. The project was expected to produce annual after-tax cash flows of $135,000.

Required:

1. Compute the NPV for Campbell Manufacturing, assuming a discount rate of 12%. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV.
$

Should the company buy the new welding system?
No

2. Conceptual Connection: Assuming a required rate of return of 8%, calculate the NPV for Evee Cardenas' investment. Round to the nearest dollar. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV.
$

Should she invest?

What if the estimated return was $135,000 per year? Calculate the new NPV for Evee Cardenas' investment. Would this affect the decision? What does this tell you about your analysis? Round to the nearest dollar.
$

The shop   be purchased. This reveals that the decision to accept or reject in this case is affected by differences in estimated  

3. What was the required investment for Barker Company's project? Round to the nearest dollar. If required, round all present value calculations to the nearest dollar.
$

Answer 1

Net Present Value = Present Value of Future cash flows - Initial Investment

1) NPV of Campbell Manufacturing

Initial Investment = $ 2,850,000

After Tax future cash flow per Year = $ 480,000 per Year

Discount Rate = 12%

Life of the Project = 10 Years

Present value of Future cashflow = Future Cash flows per Year * Present Value of Annuity factor of discount rate

( Here future cash flows are uniform for all years that's why we take present value of annuity factor to get present value of all future cash flows. It's easy way to do this. If future cash flows are different for each year this will be not possible.In that case we can calculate each year cash flows using corresponding year P.V factor. and sum up all year P.V cashflow.)

Present value of annuity of 12% for 10 Years = 5.6502 (Refer p.v annuity table )

Present value of Future cashflow = 480000 * 5.6502 = $ 2712096

NPV = 2712096 - 2850000 = - 137904

Here NPV is a negative value so this project must be rejected

2) A) NPV of Evee Cardenas

Initial Investment = $ 180,000

After Tax future cash flow per Year = $ 40,000 per Year

Discount Rate = 8%

Life of the Project = 6 Years

Present value of Future cashflow = Future Cash flows per Year * Present Value of Annuity factor of discount rate

Present value of annuity of 8% for 6 Years = 4.6229 (Refer p.v annuity table )

Present value of Future cashflow = 40000 * 4.6229 = $ 184916

NPV = 184916 - 180000 = $ 4916

Here NPV is a positive value. So she must accept this project

B) If future cash flows per year is $135000

Present value of Future cashflow = 135000 * 4.6229 = 624091.5= 624092

NPV = 624092 - 180000 = $ 444092

In both cases NPV remain positive so project must be accepted in both case. So there is no need to change the decision. In second case she can earn more when compare with first one.

3) Required investment for Barker Company's project

Initial Investment = ?

After Tax future cash flow per Year = $ 135,000 per Year

Discount Rate = 10 %

Life of the Project = 8 Years

NPV of project = 63900

Present value of annuity of 10% for 8 Years = 5.3349 (Refer p.v annuity table )

Present value of Future cashflow = 135000 *5.3349 = $ 720211.5 = $ 720212

Here we need to find out initial investment

Net Present Value = Present Value of Future cash flows - Initial Investment

Here NPV and PV of future cashflows are known So

63900 = 720212 - Initial investment

Initial Investment = 720212 - 63900 = 656312