Question

Net Present Value

An organization’s initial outlay for a proposed capital budgeting project is $1,000,000. Use the table below to calculate the net present value.

Free Cash Flows
Year	Amount		Year	Amount
1	$250,000.00		4	$310,000.00
2	$60,000.00		5	$75,000.00
3	$0.00		6	$380,000.00

You are the CEO of the company. If the firm’s cost of capital is 8%, how likely would you be to approve this project when the net present value is $1.00? Would you be more or less likely to approve the project if the net present value were $100,000.00?

Answer 1

Net Present Value (NPV)

Year	Annual Cash Inflow ($)	Present Value Factor at 8%	Present Value of Annual Cash Inflow ($)
1	2,50,000.00	0.92593	2,31,481.48
2	60,000.00	0.85734	51,440.33
3	0-	0.79383	0-
4	3,10,000.00	0.73503	2,27,859.25
5	75,000.00	0.68058	51,043.74
6	3,80,000.00	0.63017	2,39,464.46
TOTAL			8,01,289.26

Net Present Value = Present Value of annual cash inflows – Initial Investment

= $8,01,289.26 - $10,00,000

= -$1,98,710.74 (Negative NPV)

DECISION

-As per Net Present Value (NPV) analysis, the Project should be accepted only if the NPV of the Project is positive (Greater than $0), else it is rejected. Here, the Net Present Value (NPV) of the Project is Negative $198,710.74 and therefore, the organization should reject the Project.

-The should be accepted even if the NPV of $1.00 or $100,000

NOTE

The Formula for calculating the Present Value Factor is is [1/(1 + r)ⁿ], Where “r” is the Discount Rate and “n” is the number of years.