Question

A project has the following projected cash flows

Year 0- R280,000( investment)

Year 1 R70,000

Year 2 R100,000

Year 3 R130,000

a) Assuming a discount rate of 10% what is the Net Present Value (NPV) of this project over the 3 year period?

b) Based on your answer above, should the project be recommended for acceptance?

c) would your answer to b above change if the discount rate was 5%? Why?

d) what do you understand by the term nominal cash flows? In terms of the nominal cash flows above , at approximately what point does the project break-even?

Answer 1

Answer a):

With discount rate of 10%, Net Present Value (NPV) of this project over the 3 year period

= - R36,048

Workings are as below:

Answer b):

As the NPV is negative, project is not recommended.

Answer c):

Even if we change the discount rate to 5%, still NPV is negative; as such answer will not change. At discount rate of 5%, the NPV is - R10,331 and project is not recommended.

Workings are as below:

Answer d):

Nominal cash flows are the future cash flows with any adjustment made for inflation.

We find the cumulative cash flows over year 1,2 and 3 as follows:

From cumulative cash flows we find that project will break-even in year 3.

Break-even point = 2 + 110,000 / 130,000 = 2.85 years