Question

Net Present Value A project has estimated annual net cash flows of $8,750 for two years and is estimated to cost $44,726. Assume a minimum acceptable rate of return of 12%. Use the Present Value of an Annuity of $1 at Compound Interest table below. Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.352 2.991 6 4.917 4.355 4.111 3.784 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192 Determine (1) the net present value of the project (if required, round to the nearest dollar) and (2) the present value index (rounded to two decimal places). If required, use the minus sign to indicate a negative net present value. (1) Net present value of the project $ (2) Present value index

Answer 1

• All working forms part of the answer
• Net present value = Present Value of future cash inflows – Initial outflow

Present value of annual cash flows = Annual cash flows x Annuity factory for number of period.

Annuity factor for 12% for 2 years = 1.690

Present Value of 2 years net cash flows = $ 8,750 x 1.690 = $ 8,748

• Requirement 1

Net present value (NPV) = PV of annual cash flows – Initial cost

= 8748 – 44726

NPV = - $35,978 [Negative NPV]

• Requirement 2

The present value index is calculated by dividing the present value of the project's future cash flows by the initial investment.

Present Value Index = $ 8,748 / $ 44,726 = 0.20