Question

2.1 You can make an investment that will immediately cost $52,000. If you make the investment, your after-tax operating profit will be $13,000 per year for five years. After the five years, the profit will be zero, and the scrap value also will be zero. You will finance the investment with internally generated funds and receive the profit at the end of each year.

1. What is the net present value equation for this investment?
2. If your discount rate is 6 percent, will you make the investment?
3. If your discount rate is 9 percent, will you make the investment?
4. Are your answers to parts b and c the same or different? Why?

Answer 1

ANSWER:

A) NPV = Initial investment + after tax operating profit(p/a,i,n)

NPV = -52,000 + 13,000(P/A,I,5)

B) if i = 6%

npv = -52,000 + 13,000(p/a,6%,5)

npv = -52,000 + 13,000 * 4.212

npv = -52,000 + 54,756

npv = 2,756

project is viable.

C) if i = 9%

npv = -52,000 + 13,000(p/a,9%,5)

npv = -52,000 + 13,000 * 3.89

npv = -52,000 + 50,570

npv = -$1,430

project is not viable.

D) They are different as with higher interest rate , the investment value is negative that is at 6% the project is viable while at 9% it is not viable and so with higher interest rate , the present value of the profit becomes less then the initial investment.