question archive Matthew is evaluating the feasibility of purchasing a factory
Matthew is evaluating the feasibility of purchasing a factory
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Matthew is evaluating the feasibility of purchasing a factory. He will have to make an upfront payment of $1,470,000. He will then need to invest $900,000 one year from now and $950,000 two years from now to upgrade and expand the facilities. The factory is expected to generate net returns of $380,000 from the second year onwards. He plans to sell the factory at the end of eight years for $4,000,000. His required rate of return is 15%. Using the net present value (NPV) criterion, determine if he should accept or reject this project.
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Answer:
Net Cash Flow for 2nd year = Cash Inflow from Return-Cash Outflow for upgrade = 380000-950000 = -570000
| Year | Discounting Factor [1/(1.15^year)] |
Cash Flow | PV of Cash Flows (cash flow*discounting factor) |
| 0 | 1 | -1470000 | -1470000 |
| 1 | 0.869565217 | -900000 | -782608.6957 |
| 2 | 0.756143667 | -570000 | -431001.8904 |
| 3 | 0.657516232 | 380000 | 249856.1683 |
| 4 | 0.571753246 | 380000 | 217266.2333 |
| 5 | 0.497176735 | 380000 | 188927.1594 |
| 6 | 0.432327596 | 380000 | 164284.4864 |
| 7 | 0.37593704 | 380000 | 142856.0752 |
| 8 | 0.326901774 | 380000 | 124222.6741 |
| 8 | 0.326901774 | 4000000 | 1307607.095 |
| NPV = Sum of PVs |
-288590.6939 |
As NPV is Negative, Project should be Rejected
