Question

You have been hired to perform a feasibility study on a new accounting software that requires...

You have been hired to perform a feasibility study on a new accounting software that requires an initial investment of $9 million. This project will last 8 years. The company expects a total of $2 million in free cash flow in the first year. After one year the remaining annual free cash flows will be revised either upward to $3 million or downward to $500,000. Each revision has an equal probability of occurring. At that time (i.e. one year from now), the project can be abandoned and sold off for $3.7 million after tax. If the project is not liquidated the cash flow will continue for 7 more years, starting at year 2.

The relevant discount rate is 10 percent. What is the NPV of the project?

Select one:

a. $1465765

b. $439179

c. $1138753

d. $765798

e. $1411769

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Homework Answers

Answer #1

Scenario 1 :- Cash Flow rose upwards to 3 million:

PV after 1 year of future cash flows:- PVAF(10%,7)*3= 14.61 million

Scenario 2:- Cash flow fall downwards to 0.5million

PV after 1 year of future cash flow:- PVAF (10%,7)*.5= 2.43 million

so it is better to abanon the project and sell it for 3.7 million

Expected Cash flow including both Scenarios and that year inflow:- 14.61*.5+3.7*.5+2 = 11.15 million

Net Present Value of Project today

= 11,152,628/1.1-9000000

=10,138,753-9,000,000

=1,138,753

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