5. An analysis of a proposal by the net present value method indicated that the

Question

5. An analysis of a proposal by the net present value method indicated that the present value of future cash inflows exceeded the amount to be invested. Which of the following statements best describes the results of this analysis? The proposal is undesirable and the rate of return expected from the proposal is less than the minimum rate used for the analysis The proposal is desirable and the rate of return expected from the proposal is less than a. b. the minimum rate used for the analysis. The proposal is undesirable and the rate of return expected from the proposal exceeds the c. minimum rate used for the analysis. The proposal is desirable and the rate of return expected from the proposal exceeds the minimum rate used for the analysis. d. Below is a table for the present value of S1 at Compound interest Year 6% 943 890 840 .792 747 10% 909 826 751 .683 12% 893 797 712 636 567 Below is a table for the present value of an annuity of $1I at compound interest. Year 6% 943 1.833 2.673 3.465 4.212 10% 909 1.736 2.487 3.170 3.791 12% 893 1.690 2.402 3.037 3.605 4 Using the tables above, what would be the internal rate of return of an investment of $294,840 that would generate an annual cash inflow of $70,000 for the next 5 years? a. 12% b. 6% c.. 10% d. cannot be determined from the data given. Using the tables above, if an investment is made now for $23,500 that will generate a cash inflow of $8,000 a year for the next 4 years, what would be the net present value (rounded to the nearest dollar) of the investment, (assuming an earnings rate of 10%)? a. $23,500 b. $1,860 c. $25,360 d. $16,050 6. 7.

Explanation / Answer

It indicates that the project is financially viable and is expected to give more rate of return than the rate used for analysis.

NPV is the amount by how much income will we earn in present terms for the amount invested today. So if its positive that means the project is good and it will give more rate of return than what used for analysis

Initial cash outflow = $294,840

Cash inflow = 70,000

Life = 5 year

IRR is the discount rate which satisfies the following condition:

PV of cash Inflow = Initial cash outflow

Cash inflow per year * PVAF = Initial cash outflow

70,000 * PVAF = $294,840

PVAF = 4.212

So at PVAF of 4.212 at 5 years, IRR conditions will be met.

As we can see from the question that 4.212is the PVAF @6% for 5 years, so % is the rate of IRR

IRR = 6%

Cost of capital = 10%

PVAF @10% for 4 Years = 3.17

NPV = PV of cash Inflows – Initial Cash outflow

= ($8,000 * 3.17) - $23,500

NPV = $1,860

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