Question

Brewster's is considering a project with a life of 5 years and an initial cost of $120,000. The discount rate for the project is 12 percent. The firm expects to sell 2,100 units a year at a net cash flow per unit of $20. The firm will have the option to abandon this project after three years at which time it could sell the project for $50,000. The firm is interested in knowing how the project will perform if the sales forecasts for Years 4 and 5 of the project are revised such that there is a 50 percent chance the sales will be either 1,400 or 2,500 units a year. What is the net present value of this project given these revised sales forecasts? Select one:a. $23,617b. $23,719c. $25,002d. $26,877e. $28,745

Answer 1

Answer:

Net present value 27.792‬

Explanation:

Sales 2.100 units x 20 net cash flow = $ 42,000 cash flow per year

Present value of the first three years:

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$

C 42,000

time 3 years

discount rate: 0.12

$42000 \times \frac{1-(1+0.12)^{-3} }{0.12} = PV$

PV $100,876.9133

For year 4 and 5 we need to check for the expected cashflow

We will multiply each outcome by their probability:

1,400 units x $20 per unit x 0.5 chance =  14,000

2,500 units x $20 per unit x 0.5 chance = 25,000

expected return:    39,000

present value of these years:

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity  $39,000.0000

time   4 end of year 4th

rate  0.12

$\frac{39000}{(1 + 0.12)^{4} } = PV$  

PV   24,785.21

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity  $39,000.0000

time   5 end of year 5th

rate  0.12

$\frac{39000}{(1 + 0.12)^{5} } = PV$  

PV   22,129.65

Net present value will be the present value of the cash flow less the investment.

100,877 + 24,785 + 22,130 - 120,000 = 27.792‬