Question

Falkland, Inc., is considering the purchase of a patent that has a cost of $51,000 and an estimated revenue producing life of 4 years. Falkland has a cost of capital of 8%. The patent is expected to generate the following amounts of annual income and cash flows:

	Year 1	Year 2	Year 3	Year 4
Net income	$5,100	$6,500	$6,300	$3,000
Operating cash flows	17,050	18,350	18,400	14,700

(Click here to see present value and future value tables)

A. What is the NPV of the investment? Round your present value factor to three decimal places and final answer to the nearest dollar.

$

B. What happens if the required rate of return increases?

If the required rate of return increases, the NPV will be lower .

Answer 1

A. Calculation of NPV

NPV = Present value of operating cash flows - Initial investment

=[ 17050*PVIF,8%,1 + 18350*PVIF,8%,2 + 18400*PVIF,8%,3 + 14700*PVIF,8%,4 ] - 51000

= 17050*.926 + 18350*.857 + 18400*.794 + 14700*.735 - 51000

=15,788.3+15,725.95+14,609.60+10804.50 - 51000

=5928

NOTE-The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)n], where “r” is Discount rate and “n” is the useful life of investment

B. If the required rate of return increases, the NPV will be lower. Higher the rate of return,the PV of cash flows will be lower and as a result NPV also will be lower