Question

Assume that a proposed investment project requires an initial investment of $10 million and the expected cash flow is $2 million each year for the next five years. Starting from year 6, the project will have a perpetual net operating cash flow of $1.2 million each year. The project’s cost of capital is 15%. What is the project’s NPV?

Your answer: $_______________million (Keep two decimals; Do include the “-” if your answer is a negative number.)

Answer 1

Initial Investment = $10 million
Expected Cash Flows for first 5 years = $2 million
Net Operating Cash Flow for 6 years and onward = $1.20 million
Cost of Capital = 15%

Value of Net Operating Cash Flow at end of 5 years = Net Operating Cash Flow for 6 years and onward / Cost of Capital
Value of Net Operating Cash Flow at end of 5 years = $1.20 million / 0.15
Value of Net Operating Cash Flow at end of 5 years = $8 million

Net Present Value = -$10 million + $2 million/1.15 + $2 million/1.15^2 + $2 million/1.15^3 + $2 million/1.15^4 + $2 million/1.15^5 + $8 million/1.15^5
Net Present Value = $0.68 million

NPV of the project is $0.68 million