Suppose Blue Hamster Manufacturing Inc, is evaluating a proposed capital budgeti

ID: 2725755 • Letter: S

Question

Suppose Blue Hamster Manufacturing Inc, is evaluating a proposed capital budgeting project (project alpha) that will require an initial investment of $550,000. The project is expected to generate the following net cash flows:

Year

Cash Flow

Year 1

$275,000

Year 2

$400,000

Year 3

$425,000

Year 4

$450,000

1. Blue Hamster Manufacturing Inc’s weighted average cost of the capital is 8%, and project alpha has the same risk as the firm’s average project. Based on the cash flows, what is project Alpha’s net present value (NPV)?

a. $1,140,707

b. $715,707

c. $1,115,707

d. $165,707

2. Blue Hamster Manufacturing Inc’s decision to accept or reject project Alpha is independent of its decisions on other projects. If the firms follows the NPV method, it should ______ project alpha

a. Accept

b. Reject

Year

Cash Flow

Year 1

$275,000

Year 2

$400,000

Year 3

$425,000

Year 4

$450,000

Explanation / Answer

NPV is the sum of present values of all cash flows of a project. Present values are calculated by multiplying cash flows with PV factors.

Year

Cash flow

PV factor 8%

-550000

1.00000

-550000.00

275000

0.92593

254629.63

400000

0.85734

342935.53

425000

0.79383

337378.70

450000

0.73503

330763.43

715707.29

NPV = 715,707.29.

Since the NPV is positive, this project should be accepted and undertaken.