1)The cost of a project is $500,000 and the present value of the net cash inflows is $625,000. What is the increase in value of the firm as a result of accepting the project.2)A project has an initial outlay of $100,000, a cash inflow of $133,000 at the end of three years, and an IRR of 10%. At a discount rate of 10% what is the NPV?3)You are choosing between mutually exclusive projects A and B. Project A has a NPV of $10,000 and an IRR of 15%. Project B has a NPV of $6,500 and an IRR of 23%. Which project should be selected?4)When projecting cash flows into the future and calculating net present values(NPV), the manager should NOT adjust the cash flows for inflation. What do you think and why?
1) To calculate the increase in value of the firm as a result of accepting the project, we need to find the difference between the present value of the net cash inflows and the cost of the project.
Increase in value = Present value of net cash inflows - Cost of the project
Increase in value = $625,000 - $500,000
Increase in value = $125,000
Therefore, accepting the project would result in an increase in firm value of $125,000.
2) To calculate the Net Present Value (NPV) of the project, we need to discount the cash inflow at the discount rate and subtract the initial outlay.
NPV = Cash inflow / (1 + Discount rate) ^ Time period - Initial outlay
Using the given information:
Discount rate = 10%
Initial outlay = $100,000
Cash inflow after 3 years = $133,000
NPV = $133,000 / (1 + 0.10)^3 - $100,000
NPV = $133,000 / 1.10^3 - $100,000
NPV = $133,000 / 1.331 - $100,000
NPV = $99,851.47 - $100,000
NPV = -$148.53 (rounded to the nearest dollar)
Therefore, at a discount rate of 10%, the NPV of the project is -$148.53.
3) To determine which project should be selected, we can compare the NPV values of project A and project B.
If both projects have positive NPVs, then the project with the higher NPV should be selected. However, if one project has a negative NPV while the other has a positive NPV, the project with the positive NPV should be chosen.
In this case:
- Project A has an NPV of $10,000 and an IRR of 15%.
- Project B has an NPV of $6,500 and an IRR of 23%.
Both projects have positive NPVs, so we compare the NPV values:
Project A NPV = $10,000
Project B NPV = $6,500
Project A has a higher NPV than Project B, so Project A should be selected.
4) The statement "the manager should NOT adjust the cash flows for inflation" is not correct. When projecting cash flows into the future and calculating net present values (NPV), it is important to adjust the cash flows for inflation.
Inflation erodes the purchasing power of money over time. Therefore, if we do not adjust the cash flows for inflation, we would underestimate the future value of the cash flows.
To account for inflation, we need to discount the future cash flows at a rate that incorporates the expected inflation rate. This ensures that the cash flows are properly adjusted to their present value equivalents.
By adjusting the cash flows for inflation, we can make more accurate financial decisions regarding investment projects and evaluate their profitability. So, it is crucial to consider inflation when projecting cash flows and calculating NPV.