Net present value: Lady Grey Enterprises plans to build a new plant at a cost of $3,250,000. The plant is expected to generate annual cash flows of $1,225,000 for the next five years. If the company's required rate of return is 18 percent, what is the NPV of this project?

Question

Quizplus · Accepted Answer

To calculate the NPV, we need to discount the future cash flows back to the present value using the required rate of return of 18%.

So,

Year 1 cash flow = $1,225,000 / (1 + 0.18)^1 = $1,034,746

Year 2 cash flow = $1,225,000 / (1 + 0.18)^2 = $875,613

Year 3 cash flow = $1,225,000 / (1 + 0.18)^3 = $740,223

Year 4 cash flow = $1,225,000 / (1 + 0.18)^4 = $624,452

Year 5 cash flow = $1,225,000 / (1 + 0.18)^5 = $525,885

Total discounted cash flows = $1,034,746 + $875,613 + $740,223 + $624,452 + $525,885 = $3,801,919

Now, subtract the initial investment of $3,250,000 from the total discounted cash flows to get the NPV:

NPV = $3,801,919 - $3,250,000 = $551,919

Therefore, the NPV of the project is $580,785, which is the closest option to our calculated NPV. Hence, the best choice is C).

Net Present Value: Lady Grey Enterprises Plans to Build a New