Question

In: Accounting

Wise Company is considering an investment that requires an outlay of $600,000 and promises an after-tax...

Wise Company is considering an investment that requires an outlay of $600,000 and promises an after-tax cash inflow of $693,000 one year from now. The company's cost of capital os 10%.

1. Break the $693,000 future cash inflow into three components: (a) the return of the original investment, (b) the cost of capital and, (c) the profit earned on the investment. Now compute the present value of the profit earned on the investment.

2. Conceptual Connection: Compute the NPV of the investment. Compare this with the present value of the profit computed in Requirement 1. What does this tell you about the NPV.

Please show all work.

Solutions

Expert Solution

1) Initial cash outflow= $6,00,000

After tax cash inflow after one year = $6,93,000

Cost of capital= 10%

Breaking of future cash inflow of $ 693,000 in a) Return of original investment

b) Cost of capital

c) Profit earned on investment

a) Return of original investment

= $600,000

b) Cost of capital

= $600,000*10% = $60,000

c) Profit earned on investment

= $693,000-$600,000-$60,000 = $33,000

Present value of profit earned on investment

present value factor of 10% for one year = 0.909

so, present value of profit earned on investment = $33,000*0.909

= $29,997

2) Computation of NPV

NPV= Present value of cash inflow- present value of cash outflow

Present value of cash inflow= $693,000*0.909 = $629,937

Present value of cash outflow = $600,000

NPV= $629,937-$600,000 = $29,937

NPV and Present value of profit earned on investment are almost equal.

This tell us that Present value of Profit earned on investment is the NPV of investment.

ekkarill92 answered 1 year ago
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