Question

8- The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash inflow of $97,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 4% per year for the following 5 years. The project requires an initial investment of $1,500,000. If Yurdone requires an 11% return, should the cemetery business be started? (Note: to calculate the next years cash flow, multiply last years cash flow by 1 + the growth rate. For example, cash flow for year 2 will be $97,000*(1+4%) = $100,880).

Answer 1

Year 1 cash flow = 97,000

Year 2 cash flow = 97,000 * 1.04 = 100,880

Year 3 cash flow = 100,880 * 1.04 = 104,915.2

Year 4 cash flow = 104,915.2 * 1.04 = 109,111.808

Year 5 cash flow = 109,111.808 * 1.04 = 113,476.2803

Year 6 cash flow = 113,476.2803 * 1.04 = 118,015.3315

Net present value = Present value of cash inflows - present value of cash outflows

Net present value = -1,500,000 + 97,000 / (1 + 0.11)¹ + 100,880 / (1 + 0.11)² + 104,915.2 / (1 + 0.11)³ + 109,111.808 / (1 + 0.11)⁴ + 113,476.2803 / (1 + 0.11)⁵ + 118,015.3315 / (1 + 0.11)⁶

Net present value = -$1,051,709.26

Cemetery business should NOT be started as it has a negative NPV