Question

Orion Corp. is evaluating a proposal for a new project. It will cost $50,000 to get the undertaking started. The project will then generate cash inflows of $20,000 in its first year and $16,000 per year in the next five years, after which it will end. Orion uses an interest rate of 15% compounded annually for such evaluations.

1. Calculate the "Net Present Value" (NPV) of the project by treating the initial cost as a cash out-flow (a negative) in the present, and adding the present value of the subsequent cash inflows as positives

2. What is the implication of a positive NPV? (Words only.)

3. Suppose the inflows ere somewhat lower, and the NPV turned out to be negative. What would be the implication of the result? (Words only.)

Answer 1

1. Net Present Value (NPV) of the project is $14,029.98.

Detailed working as follows:

2. A positive NPV indicates that total of present value of the cash inflows (positive) over the period, after discounting with the required interest (in order to incorporate time value of money) is in excess of the present value of the cash outflows. Hence the project generates surplus in today's dollar terms.

3. In case the inflows are lower and the NPV turn out to be negative, it indicates that project in total ends up in loss because the present value of cash outflows exceeds that of inflows, in today's dollar terms.