Question

1. Please solve algebraically and show all the stops
2. Bob's firm is considering expanding by building a new superstore. The superstore will require an initial investment of $12.3 million and is expected to produce cash inflows of $1.1 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for $6.7 million. Should the firm accept or reject the superstore project and why?

Answer 1

Answer:

Initial investment = $12.3 million = $12,300,000

Life of project = 10 years

Annual cash flow = $1.1 million = $1,100,000

Salvage value = $6.7 million = $6,700,000

WACC = 10.61%

PV factor $1 annuity for period n and discount rate r = (1 - 1/ (1+ r) ^n) / r

PV factor of $1 for period n and discount rate r = 1/ (1 + r) ^n

NPV = PV of annual cash flows + PV of salvage value - Initial investment

= 1100000 * (1 - 1 / (1+ 10.61%) ^10)/ 10.61% + 6700000 * 1/ (1 + 10.61%)^10 - 12300000

= - $3270358.45

NPV = - $3,270,358.45 or - $3.27 million

The firm should reject the superstore project. NPV of the superstore project is negative.