Question

A project requires an initial investment in equipment and machinery of $10 million. The equipment is expected to have a five-year lifetime with no salvage value and will be depreciated on a straight-line basis. The project is expected to generate revenues of $5.1 million each year for the five years and have operating expenses (not including depreciation) amounting to one-third of revenues. Assume the tax rate is 40% and the cost of capital is 10%. What is the net present value of the project? (choose the nearest number)

Select one: a. $2.89 million b. $0.77 million c. –$2.27 million d. –$6.82 million

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:

Annual net cash flow is computed as follows:

= (Sales - variable cost - depreciation) x (1 - tax rate)

= ($ 5.1 million - $ 5.1 million / 3 - $ 10 million / 5) x (1 - 0.40)

= $ 1.4 million x 0.60

= $ 0.84 million

So, the NPV will be computed as follows:

= - $ 10 million + $ 0.84 million / 1.101 + $ 0.84 million / 1.102 + $ 0.84 million / 1.103 + $ 0.84 million / 1.104 + $ 0.84 million / 1.105

= - $ 6.82 million Approximately

So, the correct answer is option d.

Feel free to ask in case of any query relating to this question