Question

A firm is considering a 4-year project with an initial investment of $400,000. During the first year of operation, the project will bring an incremental cash flow of $100,000. The firm expects that the cash flow will grow at 15% annually. The project will be terminated after the fourth year of operation. If the required rate of return for this project is 17%, should the firm accept the project based on NPV criterion?

Group of answer choices

Indifferent, because the NPV is $0.

No, because the NPV is -$66,790

Yes, because the NPV is $99,340.

No, because the NPV is -$125,680

Yes, because the NPV is $35,370

Answer 1

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)n

So, the NPV is computed as follows:

= - $ 400,000 + $ 100,000 / 1.17 + ($ 100,000 x 1.15) / 1.172 + ($ 100,000 x 1.152) / 1.173 + ($ 100,000 x 1.153) / 1.174

= - $ 400,000 + $ 100,000 / 1.17 + $ 115,000 / 1.172 + $ 132,250 / 1.173 + $ 152,087.5 / 1.174

= - $ 66,790 Approximately

So, the correct answer is option of No, because the NPV is -$66,790

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