Question

T needs you to analyze the impact a new project that will cause its cash flows to increase $8,000 over last year’s, and continue to grow at a constant rate of 10% per year for the foreseeable future. The discount rate is 20%. You need to analyze this in three ways.

1. Calculate the NPV and IRR of this new project based on an initial investment cost of $45,000 and the change in cash flows each year, assuming the growth continues forever.
2. Find the NPV and IRR of this project if the project only generates cash flows for 10 years.
3. Use an embedded function in Excel to calculate the NPV of the project if the cash flows had zero growth, and the project only generates cash flows for 20 years

Answer 1

Scenario1

If the growth continues forever, the present value of all the future cash flow (As per DDM model) would be : = 8000*(1+growth rate)/(discount rate- growth rate) =8000*(1+10%)/(20%-10%) = $88000

So, NPV= 88000-45000=$43000

If, for IRR, 45000=8000*(1+10%)/(IRR-10%) by solving IRR=29.56%

Scenario 2

If the project lasts for 10 years, then NPV would be $1487.68. Calculation given below:

For IRR calculation: 45000= 8000/(1+IRR) +8800/(1+IRR)^2+......10th cash flow

By solving above IRR=20.82%

Scenario 3

You can use PV function to discount the future cash flows into present value and substract 45000 to get the NPV

So, in this case NPV= $-6043.36