Practice Question
A firm is considering a project that will cost $250,000 today and is expected to generate cash flows of $80,000 per year for 4 years. If the required return is 10%, should the firm proceed with the project?
Answer +
Yes
Step-by-step solutions +
Step 1: Calculate the present value of cash inflows
PV = Σ (Cash inflow / (1 + r)^t)
PV = $80,000 × [(1 - (1 + 0.10)-4) / 0.10] = $80,000 × 3.16987 = $253,589.60
Step 2: Calculate NPV
NPV = PV - Initial Investment = $253,589.60 - $250,000 = $3,589.60
Conclusion
Since NPV > 0, the firm should proceed with the project.
PV = Σ (Cash inflow / (1 + r)^t)
PV = $80,000 × [(1 - (1 + 0.10)-4) / 0.10] = $80,000 × 3.16987 = $253,589.60
Step 2: Calculate NPV
NPV = PV - Initial Investment = $253,589.60 - $250,000 = $3,589.60
Conclusion
Since NPV > 0, the firm should proceed with the project.