Net Present Value Calculation: A Questionnaire

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1. This first question is a net present value calculation. The future cash flows must be discounted, because of the effects of interest and inflation. Those two factors reduce the value of cash flows in the future, so that money received or paid in the future is not worth as much as the same dollar amount paid today. In this example, there is a project, and the cash flows associated with the project need to be discounted. If the final value, the net present value (NPV) is greater than zero, the company should undertake the project. This is because the discount rate should reflect the risk of the project or the company's cost of capital. The formula for discounting is Cash Flow / (1+ discount rate)^time. The NPV calculation is best done on Excel, and here is the output: Year 0 1 2 3 Flow -549 91 182 374 PV -549 91 182 374 NPV 98 d 0 When the discount rate is 0%, the future value is the same as the present value. Thus, the future values have not been discounted and this project has a positive NPV. If the discount rate is 5%, the output is: Year 0 1 2 3 Flow -549 91 182 374 PV -549 86.66667 165.0794 323.0753 NPV 25.82129 d 0.05 The project still has a positive NPV, but this is much lower, with $25.82 million. This is because the value of some of those future cash flows is lower than it would be if there was no discounting. c. The project's internal rate of return is the rate at which the NPV would be 0%. This is found in Excel. The IRR
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