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You are evaluating a project for your company that has an open ended life
You are evaluating a project for your company that has an open ended life. Cash flow in year one is expected to be $25,000, and this cash flow is expected to grow at a rate of 5% per year for 3 years. After this 3 year period, your expectations are that the cash flows for the project will remain constant. The initial investment for the project is expected to be $110,000. Your cost of capital is 12%. Using this information, calculate the NPV for the project. Is it acceptable?
Expert Solution
Year 1 cash flow = 25,000
Year 2 cash flow = 25,000 (1 + 5%) = 26,250
Year 3 cash flow = 26,250 (1 + 5%) = 27,562.5
Year 4 cash flow = 27,562.5 (1 + 5%) = 28,940.625
Year 5 cash flow = 28,940.625
Value in year 4 = Year 5 cash flow / cost of capital
Value in year 4 = 28,940.625 / 0.12
Value in year 4 = 241,171.875
NPV = Present value of cash inflows - present value of cash outflows
Present value = Future value / (1 + rate)^periods
NPV = -110,000 + 25,000 / (1 + 0.12)^1 + 26,250 / (1 + 0.12)^2 + 27,562.5 / (1 + 0.12)^3 + 28,940.625 / (1 + 0.12)^4 + 241,171.875 / (1 + 0.12)^4
NPV = $124,527.59
Project is acceptable as NPV is positive
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