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Topic
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Salem Co. is considering a project that yields annual net cash inflows of $420,000 for years 1 through 5, and a net cash inflow of $100,000 in year 6. The project will require an initial investment of $1,800,000. Salem’s cost of capital is 10%. Present value information is presented below:
Present value of $1 for 5 years at 10% is .62.
Present value of $1 for 6 years at 10% is .56.
Present value of an annuity of $1 for 5 years at 10% is 3.79.
What was Salem’s expected net present value for this project?
a.
($108,200)
b.
($152,200)
c.
($442,000)
d.
$83,000
Explanation
Choice “b” is correct. Net present value is computed as the difference between project inflows and outflows, discounted to present value as follows:
Inflows:
Years 1 through 5: $420,000 x 3.79 =
$ 1,591,800
Year 6: $100,000 x .56 =
$ 56,000
Present value of all inflows
$ 1,647,800
Outflow (today, discount factor of 1.0)
$ 1,800,000
Net Present Value
$ 152,200
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