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NPV and maximum return   A firm can purchase new equipment for a $20,500 initial investment. The...

NPV and maximum return   A firm can purchase new equipment for a $20,500 initial investment. The equipment generates an annual​ after-tax cash inflow of $5,000 for 7 years.

a. Determine the net present value (NPV​) of the​ asset, assuming that the firm has a cost of capital of 11​%. Is the project​ acceptable?

b. Determine the maximum required rate of return that the firm can have and still accept the asset.

Solutions

Expert Solution

a

Discount rate 11.000%
Year 0 1 2 3 4 5 6 7
Cash flow stream -20500 5000 5000 5000 5000 5000 5000 5000
Discounting factor 1.000 1.110 1.232 1.368 1.518 1.685 1.870 2.076
Discounted cash flows project -20500.000 4504.505 4058.112 3655.957 3293.655 2967.257 2673.204 2408.292
NPV = Sum of discounted cash flows
NPV Project = 3060.98
Where
Discounting factor = (1 + discount rate)^(Corresponding period in years)
Discounted Cashflow= Cash flow stream/discounting factor

b

IRR is the rate at which NPV =0
IRR 15.49%
Year 0 1 2 3 4 5 6 7
Cash flow stream -20500.000 5000.000 5000.000 5000.000 5000.000 5000.000 5000.000 5000.000
Discounting factor 1.000 1.155 1.334 1.540 1.779 2.055 2.373 2.740
Discounted cash flows project -20500.000 4329.385 3748.715 3245.926 2810.573 2433.611 2107.208 1824.583
NPV = Sum of discounted cash flows
NPV Project = 0.000
Where
Discounting factor = (1 + discount rate)^(Corresponding period in years)
Discounted Cashflow= Cash flow stream/discounting factor
IRR= 15.49% = max rate

jeff jeffy answered 2 years ago
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