Given the following information how would you calculate the ability of a project to earn the company additional income using the NPV method?How do you calculate the net present value of the project...

Given the following information how would you calculate the ability of a project to earn the company additional income using the NPV method?

How do you calculate the net present value of the project using a discount rate of 5% and the following revenue flow:

Year 0 :(30000)

Year 1: 11000

Year 2: 11000

Year 3: 11000

Year 4: 11000

Year 5: 11000

Asked on by littlemay

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justaguide | College Teacher | (Level 2) Distinguished Educator

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The viability of the project has to be calculated using the NPV method. The discount rate is given as 5%.

When using the NPV method to find the net revenue flow from a project the discount rate helps in reducing the value of future inflows to what their corresponding value is right now. This is essential because of what is called the time value of money. The value of money decreases with time. The value of a revenue inflow today is worth more than what the value of a revenue inflow of the same magnitude in the future would be as the funds received now can be increased by investing them.

For the project, the revenue flow is:

Year 0 :(30000)

Year 1: 11000

Year 2: 11000

Year 3: 11000

Year 4: 11000

Year 5: 11000

Initially, there is a revenue outflow of 30000. The revenue inflow at the end of year 1 of 11000 is worth 11000/(1.05) today. Similarly, the revenue inflow of 11000 at the end of year 2 is worth 11000/(1.05)^2 today. This continues for the other inflows and revenue inflow of 11000 earned at the end of year 5 is 11000/(1.05)^5

Adding the present values of all the future inflows, we get:

11000(1/1.05 + 1/1.05^2 + 1/1.05^3 + 1/1.05^4 + 1/1.05^5)

=> 11000*4.3294

=> 47624.24

Subtracting the outflow of 30000 gives the NPV of the project as 17624.24. As the NPV of the project is positive, it is viable and the company will earn an additional income if it is implemented.

Sources:

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