esareisansan NPV: Basic Concepts Buena Vision Clinic is considering an investmen

Question

esareisansan NPV: Basic Concepts Buena Vision Clinic is considering an investment that requires an outlay of $600,000 and prom- CTIVE ises a net cash inflow one year from now of $810,000. Assume the cost of capital is 10 percent. Required 1. Break the $810,000 future cash inflow into three components: a. The return of the original investment b. The cost of capital The profit earned on the investment c. Now, compute the present value of the profit earned on the investment. Compute the NPV of the investment. Compare this with the present value of the profit com- puted in Requirement 2. What does this tell you about the meaning of NPV? 2. 3.

Explanation / Answer

1.the following is the break up of $810,000 future cash inflows:

a. return of the original investment is $600,000.............(since original investment was $600,000).

b.cost of capital = investment * cost of capital => $600,000 *10% =>$60,000.

c.profit earned on the investment = net cash inflow - cost of capital - original investment

=>$810,000 - 60,000 - 600,000

=>$150,000.

2.computing present value of profit earned on investment .

=> $150,000 * present value factor

here,

present value factor = 1 /(1+r)^n

here,

r = 10% =>0.10.

n = 1 year.

=>1 /(1.1)^1 =0.90909.

present value of profit earned = $150,000 * 0.90909

=>$136,363.

3.NPV of the investment is shown below:

SInce NPV is equal to present value of profit on investment calculated in 2 above, it can be said that NPV is nothing but the present value of profit earned on investment.

year discounting factor @10% cash flow discounted cash flow (factor* cash flow) 0 1 - $600,000 - $600,000 1 0.90909 (calculated above) $810,000 $736,363 NPV $136,363

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