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4. Cash flows of the investment project should are
forecasted based on realistic assumptions
Appropriate discount rate are identified to discount
the forecasted cash flows
Present value of cash flows is calculated using the
oppurtunity cost of capital as the discount rate
Net Present Value
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5. Accept the project when NPV is positive NPV=0
Reject the project when NPV is negative NPV<0
May accept the project when NPV is zero NPV=0
NPV=C*(PVF)-i
In the above formula:
C is the cash inflow expected to be received each period
PVF is the present value factor
I is the initial investment
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6. When cash inflows are uneven:
Net Present Value
(NPV)
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Where:
• i is the target rate of return per period
• R1 is the net cash inflow during the first period
• R2 is the net cash inflow during the second period
• R3 is the net cash inflow during the third period, and so on
...
7. Example 1: Even Cash
Inflows:
Calculate the net present value of a project which requires an initial investment
of $243,000 and it is expected to generate a cash inflow of $50,000 each month
for 12 months. Assume that the salvage value of the project is zero. The target
rate of return is 12% per annum.
Solution
We have,
Initial Investment = $243,000
Net Cash Inflow per Period = $50,000
Number of Periods = 12
Discount Rate per Period = 12% ÷ 12 = 1%
Net Present Value
= $50,000 × (1 − (1 + 1%)^-12) ÷ 1% − $243,000
= $50,000 × (1 − 1.01^-12) ÷ 0.01 − $243,000
≈ $50,000 × (1 − 0.887449) ÷ 0.01 − $243,000
≈ $50,000 × 0.112551 ÷ 0.01 − $243,000
≈ $50,000 × 11.2551 − $243,000
≈ $562,754 − $243,000
≈ $319,754
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8. Example 2: Uneven Cash
Inflows
An initial investment of $8,320 thousand on plant and machinery is
expected to generate cash inflows of $3,411 thousand, $4,070
thousand, $5,824 thousand and $2,065 thousand at the end of first,
second, third and fourth year respectively. At the end of the fourth
year, the machinery will be sold for $900 thousand. Calculate the net
present value of the investment if the discount rate is 18%. Round your
answer to nearest thousand dollars.
Solution
PV Factors:
Year 1 = 1 ÷ (1 + 18%)^1 ≈ 0.8475
Year 2 = 1 ÷ (1 + 18%)^2 ≈ 0.7182
Year 3 = 1 ÷ (1 + 18%)^3 ≈ 0.6086
Year 4 = 1 ÷ (1 + 18%)^4 ≈ 0.5158
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9. Example 2: Uneven Cash
Inflows
The rest of the calculation is summarized below:
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