A number of companies, including Litchfield Design and Oxygen Optimization, are

Question

A number of companies, including Litchfield Design and Oxygen Optimization, are considering undertaking project A, which is believed by all to have a level of risk that is equal to that of the average-risk project at Litchfield Design. Project A is a project that would require an initial investment of 6,895 dollars and then produce an expected cash flow of 11,854 dollars in 6 years. Project A has an internal rate of return of 9.452 percent. The weighted-average cost of capital for Litchfield Design is 10.97 percent and the weighted-average cost of capital for Oxygen Optimization is 12.79 percent. What is the NPV that Oxygen Optimization would compute for project A?

Explanation / Answer

Solution:

Given that Initial Investment = $6,895

Expected cash flows = $11,854

Number of years, n = 6 and

WACC for Oxygen Optimization = 12.79%

Now, we calculate the NPV

NPV = -Initial Investment + Expected cash flow (PVIFA @ WACC, n)

NPV = -6,895 + 11,854 (PVIFA @ 12.79%, 6)

NPV = -6895 + 11,854 [(1.1279^6-1)/ (0.1279*1.1279^6)]

NPV = -6895 + 11,854 (4.021)

NPV = $40,770.38

Hence, the NPV that Oxygen Optimization would compute for project A is $40,770.38.

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