Net present value: Gao 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 firm's required rate of return is 18 percent, what is the NPV of this project?

Question

Quizplus · Accepted Answer

To calculate NPV, we need to discount each year's cash flow by our required rate of return and then subtract the initial investment.
Using the formula:
NPV = - Initial Investment + PV(Cash Flows)
NPV = - 3,250,000 + [1,225,000 / (1+0.18)^1] + [1,225,000 / (1+0.18)^2] + [1,225,000 / (1+0.18)^3] + [1,225,000 / (1+0.18)^4] + [1,225,000 / (1+0.18)^5]

NPV = - 3,250,000 + [1,225,000 / 1.18] + [1,225,000 / 1.39] + [1,225,000 / 1.64] + [1,225,000 / 1.94] + [1,225,000 / 2.29]

NPV = -3,250,000 + 1,037,288 + 882,482 + 747,262 + 632,620 + 533,568

NPV = $580,785

Therefore, the best choice is C as it has the highest NPV.

Net Present Value: Gao Enterprises Plans to Build a New