Question

Fijisawa Inc. is considering a major expansion of its product line and has estimated the following free cash flows associated with such an expansion. The initial outlay would be ​$1,800,000​, and the project would generate incremental free cash flows of ​$600,000 per year for 5 years. The appropriate required rate of return is 8 percent.a. Calculate the NPV.
b. Calculate the PI.
c. Calculate the IRR.
d. Should this project be accepted?

Answer 1

Answer:

Explanation:

a.)

Using Financial calculator, enter the following CFs to find NPV;

CF0 = -1,800,000

C01 =600,000

C02 =600,000

C03 =600,000

C04= 600,000

C05 = 600,000

Interest rate ( I ) = 8%

CPT NPV = $595,626.02

b.)

Profitability Index (PI)

PI= NPV of cash inflows / Initial outlay

Using Financial calculator, enter the following CFs;

Find the NPV of the expected future cash inflows;

CF0 = 0

C01 =600,000

C02 =600,000

C03 =600,000

C04= 600,000

C05 = 600,000

Interest rate ( I ) = 8%

NPV = $2,395,626.02

PI  = $2,395,626.02/1,800,000 = 1.331

c.)

You can use a Financial calculator to find the IRR;

CF0 = -1,800,000

C01 =600,000

C02 =600,000

C03 =600,000

C04= 600,000

C05 = 600,000

CPT IRR = 19.86%

d.)

Based on the NPV rule, a company should accept a project if the NPV is greater than 0. This project's NPV of $595,626.02 meets this criteria , therefore, the project should be accepted.

Based on IRR rule, a company should accept a project if the IRR of the project is greater than the cost of capital; which is also the required return. The IRR of this project is 19.86% which is significantly higher than the cost of capital of 8% hence in agreement that the project should be accepted. The Profitability Index is also greater than 1 hence the project should be accepted.