Question

Defense Electronics, Inc. (DEI), a large publicly traded firm is the market share leader in radar detection systems (RDSs), is considering a new project producing a new line of RDSs. The project will last 5 years and is expected to generate the following net cash flows (CFFA):

Year CFFA

1 $12,450,000

2 $12,450,000

3 $12,450,000

4 $12,450,000

5 $26,575,000

a) The initial cost of this project is $38,600,000. If the appropriate discount rate for this project is 12.31%, what is the NPV of this project?

b) What is the IRR on this project?

c) Do you recommend going ahead with this project? Why or why not? Clearly explain your answer.

Answer 1

a.Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=12,450,000/1.1231+12,450,000/1.1231^2+12,450,000/1.1231^3+12,450,000/1.1231^4+26,575,000/1.1231^5

=$52,441,829.73

NPV=Present value of inflows-Present value of outflows

=$52,441,829.73-$38,600,000

=$13,841,829.73(Approx).

b.

Let irr be x%
At irr,present value of inflows=present value of outflows.

$38,600,000=12,450,000/1.0x+12,450,000/1.0x^2+12,450,000/1.0x^3+12,450,000/1.0x^4+26,575,000/1.0x^5

Hence x=irr=24.44%(Approx).

c.

Hence since NPV is positive;project should be went ahead with.(Also irr is greater than the discount rate for the project).