Question

Evaluating cash flows with the NPV method

The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions.

Consider this case:

Suppose Black Sheep Broadcasting Company is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $2,750,000. The project is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$300,000
Year 2	$500,000
Year 3	$500,000
Year 4	$450,000

Black Sheep Broadcasting Company’s weighted average cost of capital is 9%, and project Beta has the same risk as the firm’s average project. Based on the cash flows, what is project Beta’s NPV?

-$1,349,048

-$899,048

-$849,048

-$1,551,405

Making the accept or reject decision

Black Sheep Broadcasting Company’s decision to accept or reject project Beta is independent of its decisions on other projects. If the firm follows the NPV method, it should (accept/reject) project Beta.

Answer 1

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$2,750,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the weighted average cost of capital of 9%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 9% weighted average cost of capital is $1,349,047.56 $1,349,048.

Hence, the answer is option a.

Therefore, Black Sheep Broadcasting company should accept project Beta since it generates a positive net present value.

In case of any query, kindly comment on the solution.