Question

Fijisawa Inc. is considering a major expansion of its product line and has estimated the following cash flows associated with such an expansion. The initial outlay would be

​$1,850,000​,

and the project would generate incremental free cash flows of

​$700,000

per year for

6

years. The appropriate required rate of return is

8

percent.

a. Calculate the

NPV.

b. Calculate the

PI.

c. Calculate the

IRR.

d. Should this project be​ accepted?

Answer 1

a.Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$1,850,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the required rate of return of 8%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 8% required rate of return is $1,386,015.77.

b.Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$1,850,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project is 19.9980% 20%.

c. Profitability Index= PV of future cash flows/Initial investment

PV of future cash flows is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= $1,850,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the third cash flow cash flow, press the NPV button and enter the interest rate.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $1,386,015.77.

Profitability Index= $1,386,015.77/$1,850,000= 0.75.

d.The project should be accepted since it has a positive net present value.

In case of any query, kindly comment on the solution.