Suppose your firm is considering investing in a project with

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively. Time: 0 1 2 3 4 5 6 Cash flow: –$5,000 $1,200 $2,400 $1,600 $1,600 $1,400 $1,200 Use the NPV decision rule to evaluate this project.

Solution

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=1200/1.08+2400/1.08^2+1600/1.08^3+1600/1.08^4+1400/1.08^5+1200/1.08^6

=$7323.92

NPV=Present value of inflows-Present value of outflows

=$7323.92-$5000

=$2323.92(Approx).

Hence since NPV is positive;project must be accepted.