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A firm is considering a simple investment project. If it goes forward, then the firm must pay $6 million now and $4 million in one year. Two years from now the project is expected to pay back $5 million, and three years from now it is expected to pay back another $10 million. Suppose that the firm’s opportunity cost of capital is 25%. (a) What is the present value of the project? (b) Under what conditions should the firm do the project?

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facundobuzzetti

Answer:

Explanation:

Giving the following information:

The firm must pay $6 million now and $4 million in one year. Two years from now the project is expected to pay back $5 million, and three years from now it is expected to pay back another $10 million.

Io= -6,000,000

1= 4,000,000

2= 5,000,000

3= 10,000,000

i=0.25

We need to use the following formula:

NPV= -Io + ∑[Cf/(1+i)^n]

Cf= cash flow

NPV= 5,520,000

The firm should do the project when the net present value is positive.