NPV = Initial cash outlay + PV of all the cash inflows.
PV of cash flow at time n = Cash flow at time n/ ((1+r)^n).
NPV = - CF0 + (CF1/((1+WACC)^1)) + (CF2/((1+WACC)^2)) + (CF3/((1+WACC)^3)) + (CFn/((1+WACC)^n)).
Profitability Index (PI)=
1 + (NPV/Initial Investment).
Machine MIR (RM) Machine ZA (RM)
Years Total Cash flows PV Total Cash flows PV
0 (17,000) (17,000.00) (17,000) (17,000.00)
1 8,000 7,272.73 2,000 1,818.18
2 7,000 5,785.12 5,000 4,132.23
3 5,000 3,756.57 9,000 6,761.83
4 3,000 2,049.04 9,500 6,488.63
Required return 10.00% 10.00%
NPV 1,863.5 NPV 2,200.9
PI 1.11 PI 1.13
The most important feature of the net present value method is that it is based on the idea that future dollars will be less valuable today than bank dollars. Future cash flows are discounted to date to determine their value.
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