   Chapter 26, Problem 26.3APE

Chapter
Section
Textbook Problem

Net present valueA project has estimated annual net cash flows of $8,000 for five years and is estimated to cost$28,000. Assume a minimum acceptable rate of return of 12%. Using Exhibit 5, determine (1) the net present value of the project and (2) the present value index, rounded to two decimal places.

(1)

To determine

Net present value method:

Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is determined by the business, based on the net income from the investment, and it is also called as the discounted cash flow method.

To calculate: The net present value of the investment.

Explanation

The net present value of the project with 12% rate of return is \$840.

Working Note:

Calculation of NPV of the Project:

NPV=(Presentvalueofcashflows)-(Initial

(2)

To determine

Present value index:

Present value index is a technique, which is used to rank the proposals of the business.  It is used by the management when the business has more investment proposals, and limited fund.

The present value index is computed as follows:

Present value index =Total present value of net cash flowAmount to be invested

To calculate: The present value index of the investment.

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