A project requires an investment of $900 today. It can generate sales of $1,100 per year forever. Costs are $600 for the first year and will increase by 20 percent per year. (Assume all sales and costs occur at year-end [i.e., costs are $600 @ t = 1].)The project can be terminated at any time without cost. Ignore taxes and calculate the NPV of the project at a 12 percent discount rate.
A)$65.00
B)$57.51
C)$100.00
D)It cannot be calculated as g r.

Question

A project requires an investment of $900 today. It can generate sales of $1,100 per year forever. Costs are $600 for the first year and will increase by 20 percent per year. (Assume all sales and costs occur at year-end [i.e., costs are $600 @ t = 1].)The project can be terminated at any time without cost. Ignore taxes and calculate the NPV of the project at a 12 percent discount rate.
A)$65.00
B)$57.51
C)$100.00
D)It cannot be calculated as g > r.

Quizplus · Accepted Answer

The perpetuity formula is used to calculate the annual cash flows generated by the project: $1,100 - ($600 x (1 + 0.2)^t). The sum of these cash flows is then discounted back to present value using the discount rate of 12%. The perpetuity formula can be simplified as $1,100 - $600 x 1.2 x 1/(1+0.12) = $57.51. Therefore, the NPV of the project is $57.51 - $900 = -$842.49. Since the NPV is negative, the project should not be pursued.

A Project Requires an Investment of $900 Today