Question

Northwestern College is building a new science building. The initial costs are $10 million once every year for the next four years. The first cash outflow or expense is due one year from today and the last is due four years from today. The new science building will bring in an additional $3 million starting in Year 4 (i.e. four years from today). The additional revenue will grow at 1 percent per year for the next 20 years starting from Year 4. Assume the interest rate is 5 percent. (a) What is the correct interest rate to use for the initial costs (i.e. cash outflows)? Express your answer as a percentage rounded to two decimal places. (i.e. 6.538% would round to 6.54%) (3 points) (b) How many cash inflows are there in the NPV calculation? Express your answer as an integer. (2 points) (c) What is the present value of cash outflows of this project? Your answer should be expressed in the millions of dollars. DO NOT use a dollar sign, and keep three digits after the decimal point. (4 points) (d) What is the present value of cash inflows of this project? Your answer should be expressed in the millions of dollars. DO NOT use a dollar sign, and keep three digits after the decimal point. (4 points) (e) Should the new science building be built according to the NPV rule? Your answer should be either “Y” or “N” without the quotation mark. (2 points)

Answer 1

		Discount Factor at 5 %
Cash Outflow
0	10.00	1.000	10.000
1	10.00	0.952	9.524
2	10.00	0.907	9.070
3	10.00	0.864	8.638	37.232
Cash Inflow
4	3.00	0.823	2.468
5	3.03	0.784	2.374
6	3.06	0.746	2.284
7	3.09	0.711	2.197
8	3.12	0.677	2.113
9	3.15	0.645	2.032
10	3.18	0.614	1.955
11	3.22	0.585	1.881
12	3.25	0.557	1.809
13	3.28	0.530	1.740
14	3.31	0.505	1.674
15	3.35	0.481	1.610
16	3.38	0.458	1.549
17	3.41	0.436	1.490
18	3.45	0.416	1.433
19	3.48	0.396	1.378
20	3.52	0.377	1.326
21	3.55	0.359	1.275
22	3.59	0.342	1.227
23	3.62	0.326	1.180	34.993
Answers:
a) As provided in the question 'Assume Interest Rate is 5 %'
Therefore correct interest rate is to be applied 5%
b) There are 20 cash inflow.
c)Discounted Present value of cashoutflow is 37.232 million $	Discounted at 5 %
d)Discounted Present Value of the Cash inflow of the project is 34.993 million $	Discounted at 5 %
e)	N'
NOTE: CASH INFLOW INCREASED BY 1 % THAT IS TO SAY IF
CASH INFLOW FOR THE YEAR IS 3 THEN FOR NEXT
YEAR IT WILL BE 3*1.01= 3.03, YEAR AFTER 3.03*1.01=3.06 AND SO ON