the cotton clothes company is contemplating investing TZS 1500 million in four n
ID: 2614331 • Letter: T
Question
the cotton clothes company is contemplating investing TZS 1500 million in four new outlet in Ngara. Mr. Juan the CFO has estimated that the investments will pay out cash flows of TSh 200 million per year for nine years and nothing thereafter. the cash flow will occur at the end of each year and there will be no cash flow after year 9. Mr. Juan has determined that the relevant discount rate for this investment is 15 percent. this Is the rate of return that the firm can earn at comparable projects. should the cotton Clothes company make the investigates in the new outlets
Explanation / Answer
Solution:-
For the evaluation of the project we have to calculate the net present value of project (NPV). If the NPV of the project is positive the project is to be accepted , but if the NPV is negative it should not be accepted.
The NPV of project formula is
=PV of inflows - PV of outflows
PV of outflows = 1500 million ( given)
We have to calculate the Present value (PV) of inflows
Annual cash inflows(CF) = 200 million
Number of years the cash inflow occur = 9 years
Discount rate (i)= 15%
The PV of inflow can be calculated as follows:-
=CF1/(1+i)1+ CF2/(1+i)2+ CF3/(1+i)3+ CF4/(1+i)4+ CF5/(1+i)5+ CF6/(1+i)6+ CF7/(1+i)7+ CF8/(1+i)8+ CF9/(1+i)9
=200/(1+12%)1+200/(1+12%)2+200/(1+12%)3+200/(1+12%)4+200/(1+12%)5+200/(1+12%)6+200/(1+12%)7+200/(1+12%)8+200/(1+12%)9
=178.57+159.44+142.36+127.10+113.49+101.33+90.47+ 80.78+72.12
=1065.65
Hence the NPV= PV of inflows - PV of outflows
=1065.65-1500
= -434.35
Since the NPV of the project is negative so the company should not make investment in these outlets.
Instead if the company make investment in the other comparable projects it will earn more than this.
Please feel free to ask if you have any query in the comment section
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