A capacity alternative has an initial cost of $50,000 and cash flow of $20,000 for each of the next four years. If the cost of capital is 5%, the net present value of this investment is
A) greater than $80,000.
B) greater than $130,000.
C) less than $30,000.
D) impossible to calculate, because no interest rate is given.
E) impossible to calculate, because variable costs are not known.

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by discounting the future cash flows back to their present value and subtracting the initial investment. Given a cost of capital of 5%, the cash flows of $20,000 for each of the next four years are discounted back to their present value and then summed up, after which the initial cost of $50,000 is subtracted. The NPV will not exceed $30,000 because the sum of the discounted cash flows will not be sufficiently high to result in an NPV greater than $30,000 after subtracting the initial investment of $50,000.

A Capacity Alternative Has an Initial Cost of $50,000 and Cash