Question

Northern Tech has just signed a contract with its client and the total value is $2,000,000. Northern Tech expects to receive $500,000 down payment when the project starts (t=0) while the rest $1,500,000 will be paid by the end of year 2 when the project is completed. The initial investment requires $950,000, what is the net present value of this project if the required rate of return is 10%? (Set up a timeline with the info provided by the question first, then work out the question.)

Answer 1

HI,

Here at t=0 initial payment = $500,000

t=0 investment = $950,000

so at t=1 cash flow = 500,000-950,000 = -450,000

at t=1 payment = 0 and investment = 0 so cash flow = 0

at t=2 payment = $1,500,000 with no investment so cash flow = $1,500,000

so below is time line of cash flow

t=0 t=1 t=2

-450,000 0 1,500,000

Now rate of return r = 10%

NPV of project= cash flow at t=0/(1+r)^0 +cash flow at t=1/(1+r)^1 +cash flow at t=2/(1+r)^2

NPV = -450,000+0+1500000/(1+10%)^2

=-450000+1239669.42

NPV of project= $789,669.42

Thanks