Question

the project will cost $45,000 to develop. When the system becomes operational, after a one-year development period, operational costs will be $9,000 during each year of the system's five year useful life. The system will produce benefits of $30,000 in the first year of operation, and this figure will increase by a compound 10% each year. Answer the following questions based on the background information provided and what you have learned from the toolkit: What is the NPV for this project? Based on the information you calculate, is this project feasible?

Answer 1

The cash flows for this project look like as below:

Note that it has assumed that the above cash flows occur at the end of the period i.e. end of the year. For e.g., 45,000 development cost will happen at the end of the first year. Similarly the inflow of 30,000 in the second year will happen at the end of that year.

NPV:

Net present value (also known as NPV) is calculated as the present value of all the cash flows over a period of time. It is the difference in NPV of cash in flows and cash out flows. It essentially depics the serier of cash flows using a dingle metric. The follwoing formula is used to calculate the NPV for a single cash flow:

NPV = Cash flow (over a period) / (1+i) ^ n

i is the discount rate

n is the period number

However, NPV will be required to be calculated for multiple cashflows. This will then be calculated by summation of the NPV of all the cash flows within the project.

NPV for this project:

Since the rate of interests are not given, I have calcualted the NPV at three different interest rates.

Feasibility of the project:

From the values of NPV (which is positive), it appears that the project would be profitable. As a result, it might be okay to undertake this.

To under the feasibility more, I have calculated the Internal Rate of Return (IRR) for this project. This comes out to be around 48%, which again backs up the feasibility of the project.

Let me know if anything is not clear.