Question

A company’s weighted average cost of capital is 12.1% per year. A project requires a capital investment of $250,000 today and its operating costs are expected to be $150,000 per year for six years. What is the present value of the project’s costs?

Answer 1

Here, the costs will be same every year, so it is an annuity. For calculating the present value of annuity, we will use the following formula:

PVA = P * (1 - (1 + r)^-n / r)

where, PVA = Present value of annuity, P is the periodical amount = $150000, r is the rate of interest = 12.1% and n is the time period = 6

Now, putting these values in the above formula, we get,

PVA = $150000 * (1 - (1 + 12.1%)^-6 / 12.1%)

PVA = $150000 * (1 - ( 1+ 0.121)^-6 / 0.121)

PVA = $150000 * (1 - ( 1.121)^-6 / 0.121)

PVA = $150000 * (1 - 0.50392548727) / 0.121)

PVA = $150000 * (0.49607451272 / 0.121)

PVA = $150000 * 4.09978936133

PVA = $614968.40

So, present value of project's costs is $614968.40.