Question

Maud'Dib Intergalactic has a new project available on Arrakis. The cost of the project is $40,500 and it will provide cash flows of $23,400, $29,800, and $30,500 over each of the next three years, respectively. Any cash earned in Arrakis is "blocked" and must be reinvested in the country for one year at an interest of 2.6 percent. The project has a required return of 9.4 percent. What is the project's NPV?

Answer 1

Initial Cost = $ 40500, Required Return = 9.4 %, Reinvestment Rate = 2.6 %

Year 1 Cash Flow = $ 23400, Future Value after Reinvestment = F1 = 23400 x 1.026 = $ 24008.4

Year 2 Cash Flow = $ 29800, Future Value after Reinvestment = F2 = 29800 x 1.026 = $ 30574.8

Year 1 Cash Flow = $ 30500, Future Value after Reinvestment = F3 = 30500 x 1.026 = $ 31293

PV of Reinvested Cash Flows = F1 / (1.094)^(2) + F2 / (1.094)^(3) + F3 / (1.094)^(4) = 24008.4 / (1.094)^(2) + 30574.8 / (1.094)^(3) + 31293 / (1.094)^(4) = $ 65257.524

NPV = 65257.524 - 40500 = $ 24757.524