A firm evaluates all of its projects by applying the NPV decision rule. A project under consideration has the following cash flows:

Problem 9-8 Calculating NPV [LO1]

A firm evaluates all of its projects by applying the NPV decision rule. A project under consideration has the following cash flows:

  

Year	Cash Flow
0	–$	28,600
1		12,600
2		15,600
3		11,600

  

What is the NPV for the project if the required return is 11 percent?

Explanation

The NPV of a project is the PV of the inflows minus the PV of the outflows. The equation for the NPV of this project at an 11 percent required return is:

NPV = –$28,600 + $12,600/1.11 + $15,600/1.112 + $11,600/1.113 = $3,894.48

At an 11 percent required return, the NPV is positive, so we would accept the project.

The equation for the NPV of the project at a required return of 25 percent is:

NPV = –$28,600 + $12,600/1.25 + $15,600/1.252 + $11,600/1.253 = –$2,596.80

At a required return of 25 percent, the NPV is negative, so we would reject the project.

  

Calculator Solution:

    

CFo	–$28,600	CFo	–$28,600
C01	$12,600	C01	$12,600
F01	1	F01	1
C02	$15,600	C02	$15,600
F02	1	F02	1
C03	$11,600	C03	$11,600
F03	1	F03	1
I = 11%		I = 25%
NPV CPT		NPV CPT
$3,894.48		–$2,596.80