ExpertMedium1 markMultiple Choice
CPA · Question 03 · Area I: Business Analysis
Titan Industries is evaluating a new project with the following projected cash flows:<br/>- Initial Investment: $2,000,000<br/>- Year 1 Cash Inflow: $800,000<br/>- Year 2 Cash Inflow: $900,000<br/>- Year 3 Cash Inflow: $1,000,000<br/><br/>The company's Weighted Average Cost of Capital (WACC) is 10%. The present value factors for 10% are: Year 1 (0.909), Year 2 (0.826), Year 3 (0.751). <br/><br/>Calculate the Net Present Value (NPV) and determine if the project should be accepted.
Titan Industries is evaluating a new project with the following projected cash flows:<br/>- Initial Investment: $2,000,000<br/>- Year 1 Cash Inflow: $800,000<br/>- Year 2 Cash Inflow: $900,000<br/>- Year 3 Cash Inflow: $1,000,000<br/><br/>The company's Weighted Average Cost of Capital (WACC) is 10%. The present value factors for 10% are: Year 1 (0.909), Year 2 (0.826), Year 3 (0.751). <br/><br/>Calculate the Net Present Value (NPV) and determine if the project should be accepted.
Answer options:
A.
NPV = $221,600; Accept the project
B.
NPV = $700,000; Accept the project
C.
NPV = ($150,000); Reject the project
D.
NPV = $221,600; Reject the project
How to approach this question
Multiply each cash flow by its respective PV factor. Sum the PVs of inflows and subtract the initial investment. If NPV > 0, accept.
Full Answer
A.NPV = $221,600; Accept the project✓ Correct
A
PV Year 1 = $800,000 × 0.909 = $727,200<br/>PV Year 2 = $900,000 × 0.826 = $743,400<br/>PV Year 3 = $1,000,000 × 0.751 = $751,000<br/>Total PV of Inflows = $2,221,600<br/>NPV = Total PV Inflows - Initial Investment = $2,221,600 - $2,000,000 = $221,600.<br/>Since NPV is positive, the project adds value and should be accepted.
Common mistakes
Summing undiscounted cash flows; using wrong PV factors; rejecting a positive NPV.
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