Question

A firm evaluates all of its projects by using the NPV decision rule.

Year	Cash Flow
0	–$25,000
1	22,000
2	13,000
3	8,000

  

Required:
(a)	At a required return of 23 percent, what is the NPV for this project?

  

(b)	At a required return of 41 percent, what is the NPV for this project?

Answer 1

(a) The NPV of a project is the PV of the outflows minus the PV of the inflows. The equation for the NPV of this project at an 23 percent required return is:

NPV = -$25,000 + $22,000/1.23 + $13,000/1.23² + $8,000/1.23³ = $5,778.02

At an 23 percent required return, the NPV is positive, so we would accept the project.

(b) The equation for the NPV of the project at a 41 percent required return is:

NPV = -$25,000 + $22,000/1.41 + $13,000/1.41² + $8,000/1.41³ = -$4.40

At a 41 percent required return, the NPV is negative, so we would reject the project.