Stillwater Drinks is trying to determine when to harvest the water from the fountain of youth that it currently owns. If it harvests the water in year 1, the NPV of the project would increase over an immediate harvest by 18 percent. A year 2 harvest would create an NPV increase of 12 percent over that of year 1 and year 3 would create an NPV increase of 8 percent over that of year 2. If the cost of capital is 17 percent for Stillwater, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.

Question

Quizplus · Accepted Answer

The NPV increases by 18% in year 1, which is greater than the cost of capital (17%). However, the subsequent increases in years 2 and 3 (12% and 8%, respectively) are less than the cost of capital. Therefore, harvesting in year 1 maximizes the NPV since the increase in NPV from waiting exceeds the cost of capital only in the first year.

Stillwater Drinks Is Trying to Determine When to Harvest the Water