Question

Anderson International is interested in investing a project in Erewhon with the following projected cash flows:

Year	Cash flow $
0	-1,200,000
1	350,000
2	400,000
3	600,000
4	350,000
5	380,000

One problem is that the Erewhon government has declared that all cash flows created by a foreign company must be reinvested in Erewhon for two years at the rate of 3.5%. Anderson’s required rate of return is 12%.

What's the NPV of the project under the investment policy in Erewhon? Round the result to the nearest integer.

Answer 1

NPV is calculated by pulling the future cashflows of the project by the required rate of return and subtracting the Present Value of the cashflows with Initial Investment. In this case, the cash flows will be further invested. So the required rate of return that will be used for discounting will be reduced by the reinvestment rate.

New Required Rate of Return = Old Required Rate of Return - Reinvestment Rate

= 12% - 3.5%

= 8.5%

You need to use Financial calculator to solve this problem. You can download it.

Press CF in the calculator

CFo = -1,200,000 (This is the Initial Investment)

Press Arrow Down, CO1 = 350,000 (First Cashflow received after 1 year)

Press Arrow Down, CO2 = 400,000 (Second Cashflow received after 2 years)

Press Arrow Down, CO3 = 600,000 (Third Cashflow received after 3 years)

Press Arrow Down, CO4 = 350,000 (Fourth Cashflow received after 4 years)

Press Arrow Down, CO5 = 380,000 (Fifth Cashflow received after 5 years)

Press NPV button

I = 8.5 (We have already calculated it)

Press Arrow Down, NPV will appear, press CPT key

NPV= 437,375.87

So the NPV of the project is $437,375.87