Question

Yellow Sand Shipping is evaluating a 1-year project that would involve an initial investment in equipment of 24,100 dollars and an expected cash flow of 27,000 dollars in 1 year. The project has a cost of capital of 10.23 percent and an internal rate of return of 12.03 percent. If Yellow Sand Shipping were to use 24,100 dollars in cash from its bank account to purchase the equipment, the net present value of the project would be 395 dollars. However, Yellow Sand Shipping has no cash in its bank account, so using money from its account is not possible. Therefore, the firm would need to borrow money to raise the 24,100 dollars. If Yellow Sand Shipping were to borrow money to raise the 24,100 dollars, the interest rate on the loan would be 7.69 percent. Yellow Sand Shipping would receive 24,100 dollars from the bank at the start of the project and would pay 25,953 dollars to the bank in 1 year. What is the NPV of the project if Yellow Sand Shipping borrows 24,100 to pay for the project?

Answer #1

Today, there will be no net cash flow in the company as Yellow Sand Shipping will borrow money from bank on one hand and will invest the receipts in the project.

Net cash flow today = $0

After one year, the company will receive $27,000 from the project and will have to pay bank an amount of $25,953

Net cash inflow in Year 1 = $27,000 - $25,953

= $1,047

NPV of the project = Present Value of all cash flow i.e. Present value of net cash flow of $1,047 after one year

= $1,074 / 1.1023

= **$949.83**

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