Question

Sister Pools sells outdoor swimming pools and currently has an aftertax cost of capital of 11.6 percent. Al's Construction builds and sells water features and fountains and has an aftertax cost of capital of 10.3 percent. Sister Pools is considering building and selling its own water features and fountains. The sales manager of Sister Pools estimates that the water features and fountains would produce 20 percent of the firm's future total sales. The initial cash outlay for this project would be $85,000. The expected net cash inflows are $17,000 a year for 7 years. What is the net present value of the Sister Pools project?

Answer 1

Net Present Value (NPV) of the Sister Pools project

The after-tax cost of capital of Al's Construction (10.30%) shall be used for discounting the annual cash flows

Year	Annual Cash Flow ($)	Present Value factor at 10.30%	Present Value of annul Cash Flow ($)
1	17,000	0.90662	15,413
2	17,000	0.82196	13,973
3	17,000	0.74520	12,668
4	17,000	0.67561	11,485
5	17,000	0.61252	10,413
6	17,000	0.55532	9,441
7	17,000	0.50347	8,559
TOTAL		1.73554	81,952

Net Present Value (NPV) = Present value of annual cash flows – Initial Cost

= $81,952 - $85,000

= -$3,048 (Negative NPV)

“Hence, the Net Present Value (NPV) of the Sister Pools project would be -$3,048 (Negative NPV)”

NOTE    

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