ExpertMedium1 markMultiple Choice
CPA · Question 09 · Area I: Business Analysis
Project Alpha requires an initial investment of $200,000. It is expected to generate annual cash flows of $60,000 for 5 years. At the end of year 5, the equipment can be sold for $20,000. The company's required rate of return is 10%. The present value factors for 10% are:<br/>- PV of $1 (n=5): 0.621<br/>- PV of Annuity (n=5): 3.791<br/><br/>What is the Net Present Value (NPV) of the project?
Project Alpha requires an initial investment of $200,000. It is expected to generate annual cash flows of $60,000 for 5 years. At the end of year 5, the equipment can be sold for $20,000. The company's required rate of return is 10%. The present value factors for 10% are:<br/>- PV of $1 (n=5): 0.621<br/>- PV of Annuity (n=5): 3.791<br/><br/>What is the Net Present Value (NPV) of the project?
Answer options:
A.
$27,460
B.
$39,880
C.
$42,300
D.
$239,880
How to approach this question
Calculate PV of annual cash flows (Annuity factor). Calculate PV of salvage value (Single sum factor). Sum them and subtract Initial Investment.
Full Answer
B.$39,880✓ Correct
B
PV of Annual Cash Flows: $60,000 * 3.791 = $227,460<br/>PV of Salvage Value: $20,000 * 0.621 = $12,420<br/>Total PV of Inflows: $239,880<br/>Less: Initial Investment: ($200,000)<br/>NPV: $39,880
Common mistakes
Forgetting salvage value; using wrong PV factor; not subtracting initial investment.
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