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The following data on a proposed investment project have been provided: Cost of equipment $50,000 Working capital required $30,000 Salvage value of equipment $0 Annual cash inflows from the project $20,000 Required rate of return 20% Life of the project 8 years The working capital would be released for use elsewhere at the end of the project. What is the net present value of the project?

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ahmedgodtrust

Answer:

Year Cashflow DF@20%            PV

           $                        $

0         (80,000)            1  (80,000)

1-8          20,000            3.8372  76,744

8              30,000              0.2326         6,978

                 NPV          3,722

Discount factor for year 1 to 8

1 -(1+r)-n/r

1-(1+0.2)-8/0.2 = 3.8372

Discount factor for year 8

(1+r)-n  

(1+0.2)-8

Explanation:

In this case, we need to add working capital to the initial outlay ie $50,000 + $30,000 = $80,000. Then, we will discount the annual cashflows at 3.8372, which is present value of annuity factor using the formula 1 -(1+r)-n/r. We will dicount the cashflow for year 8(working capital) at discount factor for year 8 using the formula(1+r)-n . Thereafter, we will multiply the cashflows by the discount factors to obtain the present values. Finally, we will deduct the initial outlay from the present values so as to determine the NPV.

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