Answer:
D) The net present value (NPV) of the investment= $337,800
Explanation:
Net Present Value (NPV) : This is one of the techniques available to evaluate the feasibility of an investment project. The NPV of a project is the difference between the present value of the cash inflows and the cash outflows of the project. NPV is superior to other techniques for the reasons below:
- It considers the time value of money i.e it uses<em> </em>present values.
- It uses relevant cash flows rather than profit figures
- it is consistent with the shareholders' wealth maximization principle.
The Present Value (PV)of a future cash flow is the amount that needs to be invested today at a particular rate of return to equal the same cash flow in the future. Present value means the value in year 0 or now
Some times, the cash inflows from a project could be an equal amount occurring periodically, this is called an annuity. An annuity is a series of equal annual payments or receipts made for a certain number of years. Tom calculate the PV of annuity we use this formula:
PV = A × (1 - ((1+r)^(-n))/n)
where- PV- Present value, A- annual cash flow, n- number of years
In this question, the cash inflow is a five-year annuity.
<em>We now calculate the NPV;</em>
Net Present Value (NPV) = PV of cash inflows - Initial cost
<em>Remember that the inflow is an annuity, so we first calculate the PV of the annuity using this formula and then subtarct from the initial cost:</em>
PV = A × (1 - ((1+r)^(-n))/n)
PV of annuity inflow = 220,000 × ((1-(1 +0.09)^(-5))/0.09)
220,000 × 3.890
= 855,800
NPV = 855,800 - 518,000
= 337,800
What is the net present value (NPV) of the investment= $337,800
