You are also considering another project which has a physical life of 3 years; t

Question

You are also considering another project which has a physical life of 3 years; that is, the machinery will be totally worn out after 3 years. However, if the project were terminated prior to the end of 3 years, the machinery would have a positive salvage value. Here are the project’s estimated cash flows:

Initial Investment    End-of-Year

And Operating       Net Salvage

Year                          Cash Flows                          Value

0                                 ($8,000)                           $8,000

1                                    3,900                                5,100

2                                    3,000                                2,500

3                                    2,550                                       0

                 

Using the 8% cost of capital, what is the project’s NPV if it is operated for the full 3 years?

Would the NPV change if the company planned to terminate the project at the end of Year 2? At the end of Year 1?

What is the project’s optimal (economic) life?

** Please show all work! Send Excel screenshots. Thanks! **

Explanation / Answer

Initial investment = -8000
and the net salvage value if project lasts for:
3 years = 0
2 years = 2500
1 year = 5100
and this will be added to respective year Cashflow
Thus if the project lasts 3 years, Terminal year cashflow = 2550 + 0 = 2550
Thus if the project lasts 2 years, Terminal year cashflow = 3000 + 2500 = 5500
Thus if the project lasts 1 year, Terminal year cashflow = 3900 + 5100 = 9000

NPV at 8% cost of capital is as below:

Operated for full 3 years Operated for 2 years Operated for 1 year Years Cashflow Cashflow Cashflow 0 -8000 -8000 -8000 1 3900 3900 9000 2 3000 5500 3 2550 NPV at 8% $192.04 $302.29 $308.64

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.