Petrus Co. has a unique opportunity to invest in a two-year project in Australia. The project is expected to generate 1,000,000 Australian dollars (A$) in the first year and A$2,000,000 in the second. Petrus would have to invest $1,000,000 in the project. Petrus has determined that the cost of capital for similar projects is 10 percent. What is the net present value of this project if the spot rate of the Australian dollar for the two years is forecasted to be $.65 and $.80, respectively? Assume no salvage value.

$224,377

-$94,183

$913,223

$1,405,817

-$17,236

 

Answer:

• $913,223

Net present value

• Net present value is a tool of Capital budgeting to analyze the profitability of a project or investment. It is calculated by taking the difference between the present value of cash inflows and present value of cash outflows over a period of time.
• The formula for NPV varies depending on the number and consistency of future cash flows. If there's one cash flow from a project that will be paid one year from now, the calculation for the net present value is as follows.
• You must substract the initial investment.

Formula used;

NPV = -IO + (CFt / (1 +k)^n)

= [-1,000,000 (USD) + ((A$1,000,000 / (1.1) + (A$2,000,000 / (1.1)^2))]

= [-1,000,000 + (909090.9090909090)+ (1.652,892.561983471)]

= [-1,000,000 + ((909090.9090909090 x (0.65) + 1.652,892.561983471 x (0.80))]

= [-1,000,000 + (50909.0909090909 + 1,322,314.049586776)]

= -1,000,000 + 1,913,223.140495866

= 913,223.140495866 OR 913,223 to the nearest whole number