Question

Silver Sun Entertainment is evaluating a 1-year project that would involve an initial investment in equipment of 36,900 dollars and an expected cash flow of 39,600 dollars in 1 year. The project has a cost of capital of 6.63 percent and an internal rate of return of 7.32 percent. If Silver Sun Entertainment were to use 36,900 dollars in cash from its bank account to purchase the equipment, the net present value of the project would be 238 dollars. However, Silver Sun Entertainment 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 36,900 dollars. If Silver Sun Entertainment were to borrow money to raise the 36,900 dollars, the interest rate on the loan would be 3.74 percent. Silver Sun Entertainment would receive 36,900 dollars from the bank at the start of the project and would pay 38,280 dollars to the bank in 1 year. What is the NPV of the project if Silver Sun Entertainment borrows 36,900 to pay for the project?

Answer 1

The Net present Value is the difference between Presen Value of Cash Inflows and Presen Value of Cash Outflow. Usually we calcluate the difference between Present Value of CashInflows and Initial Investment, however in the present case we are having no initiial investment and the amount is payable at the end of year 1.

Present Value of Cash inflow = 39600 x .9639 (1/(1+.0374) = 38,172

Present Value of Cash OPutflow = 38280 x .9639 = 36900

Therefore NPV = 38,172-36,900 = 1272