I thought I had it until I read the second part of the wordproblem. Can you plea
ID: 2662328 • Letter: I
Question
I thought I had it until I read the second part of the wordproblem. Can you please help me and explain how to arrive at thecorrect answer to solve this?The Maroon Company will invest $60,000 in a temporary project thatwill generate the following cash flows for the next three years.The firm will also be required to spend $10,000 to close down theproject at the end of three years. If the cost of capital is 10%,should the investment be undertaken.
Year Cash Flow
1 $15,000
2 $25,000
3 $40,000
Explanation / Answer
Answer:
Initial investment(Io) = -$60,000 (minus sign as it is anoutflow)
Net cash flow after year 1= $15,000
Net cash flow after year 2= $25,000
Cash flow after year 3 =$40,000
Cash outflow requiredafter 3 years = -$10,000
Net cash flow after year 3= $40,000 – 10,000 = $30,000
Cost of capital orrequired rate of return (r) = 10% or 0.1 per year
Net present value (NPV)=?
We know that,
NPV = -Io + Cash flows / (1+r) t
NPV = -$60,000 + ($15,000/ (1+0.1) 1) + ($25,000 / (1+0.1) 2) +($30,000 / (1+0.1) 3)
NPV = -$60,000 + ($15,000/ (1.1) 1) + ($25,000 / (1.1) 2) + ($30,000 /(1.1) 3)
NPV = -$60,000 + ($15,000/ 1.1) + ($25,000 / 1.21) + ($30,000 / 1.331)
NPV = -$60,000 +($13636.3636) + ($20661.157) + ($22539.444)
NPV = -$60,000 +56836.9646
NPV = -$3163.0354or -$3163.03 a net loss, so this project should not beundertaken.