Fijisawa Inc. is considering a major expansion of its product line and has estimated the following cash flows associated with such an expansion. The initial outlay would be $1,980,000, and the project would generate incremental free cash flows of $490,000 per year for 6 years. The appropriate required rate of return is 10.8 percent
To evaluate the proposed expansion project by Fijisawa Inc., the Net Present Value (NPV) method can be used. This method helps determine the profitability of the project by comparing the present value of the cash inflows to the present value of the initial investment. Here's how you can calculate the NPV:
1. Calculate the present value (PV) of the cash inflows:
To calculate the PV of the cash inflows, we'll use the formula:
PV = CF / (1 + r)^n
where CF is the cash flow for a particular year, r is the required rate of return, and n is the year.
Year 1: CF1 = $490,000
PV1 = $490,000 / (1 + 0.108)^1
Year 2: CF2 = $490,000
PV2 = $490,000 / (1 + 0.108)^2
Year 3: CF3 = $490,000
PV3 = $490,000 / (1 + 0.108)^3
Continue this calculation for all 6 years.
2. Calculate the NPV:
To calculate the NPV, sum up all the present values of the cash inflows and subtract the initial investment.
NPV = PV1 + PV2 + PV3 + ... + PV6 - Initial Investment
Initial Investment = $1,980,000
Substitute the calculated present values into the NPV formula to find the net present value.
3. Determine the profitability:
If the NPV is positive, it indicates that the project is expected to generate more cash inflows than the initial investment, and therefore, it is considered profitable. Conversely, if the NPV is negative, the project may not be recommended.
By performing these calculations, you can find the net present value of the expansion project for Fijisawa Inc.