Sail with Us is considering a three- year advertising campaign. The campaign will cost $100,000 at the end of each of the three years. The managers of Sail with Us have estimated that the campaign will generate $80,000 a year in additional profit for the next five years. If the discount rate is 2 percent, what is the net present value of the advertising campaign?
A)$88,688
B)$90,213
C)$78,569
D)$95,228

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV), we need to find the present value of the cash inflows and outflows. The discount rate is given as 2%.

Outflows:
Year 1: $100,000
Year 2: $100,000
Year 3: $100,000

Inflows:
Year 1: $80,000
Year 2: $80,000
Year 3: $80,000
Year 4: $80,000
Year 5: $80,000

To calculate the present value of each cash flow, we use the formula PV = FV / (1 + r)^n, where PV is the present value, FV is the future value, r is the discount rate, and n is the number of years.

Present value of outflows:
Year 1: $100,000 / (1 + 0.02)^1 = $98,039
Year 2: $100,000 / (1 + 0.02)^2 = $96,144
Year 3: $100,000 / (1 + 0.02)^3 = $94,315

Present value of inflows:
Year 1: $80,000 / (1 + 0.02)^1 = $78,431
Year 2: $80,000 / (1 + 0.02)^2 = $76,923
Year 3: $80,000 / (1 + 0.02)^3 = $75,472
Year 4: $80,000 / (1 + 0.02)^4 = $74,074
Year 5: $80,000 / (1 + 0.02)^5 = $72,727

Now we can calculate the NPV by subtracting the present value of outflows from the present value of inflows:

NPV = ($78,431 + $76,923 + $75,472 + $74,074 + $72,727) - ($98,039 + $96,144 + $94,315) = $88,688

Therefore, the net present value of the advertising campaign is $88,688. The best choice is A.

Sail with Us Is Considering a Three- Year Advertising Campaign