[Anonymous]

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

[Anonymous]

0.62 is the discount factor for a payment in year five only.

You need to account for present value of $420,000 payment each year 1 through 5
plus the final $100,000 payment in year 6.

[Mehow]

Yeah, what deadpool said. Years 1-5 are equal payments like an annuity so you can use the 3.79. Then you use the single factor for the last year's piece. I think they explain this fairly well in the Becker book. If you have it take a look at it again and read the examples they give carefully.

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[Author]

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