Finance for Managers - GVP8 - 05-11-21 - Sect1 Module 5

NPV stands for Net present value. It is the difference between the present values of the cash inflows and outflows generated from the project. According to the NPV rule, a project should be acceptable if the NPV is positive and rejected if the NPV is negative. Net present value (NPV) = Present value of cash inflows-Present value of cash outflows. In this case, the project’s initial investment cost is $1,425,000. The cash inflow is $109,000 with growth rate of 5.1% forever. The required rate of return is 12%. Present value of the cash outflows is initial cost. Thus, determine the present value of the cash inflows to find the NPV. The formula for present cash flow here will be net cash inflow over r - g, where r is required rate of return and g is growth rate. So, in this case, we will have 109,000 over .12 - .051. Thus, the present net cash flow will be $1,579,710.1449. To Calculate the NPV of we use the formula NPV=present cash value inflows – present cash value out flows. This will leave us with $1,579,710.14 - $1,425,000=$154,710.14. Because NPV in this scenario equals $154,710.14, the business has positive cash flow and the project should be started. The break-even growth rate will be the rate at which the NPV of the project will be zero. Thus, present value of the net cash inflows will be equal to the present value of cash outflows. To calculate the growth rate, we use the formula NPV= - cash outflows + cash inflows over required rate – growth. After plugging in the given variables, we see that in order to break even the firm will need a constant growth rate of 4.35% to break even. Kenton, W. (January 22, 2020). Net Present Value of Growth Opportunities (NPVGO). https://www.investopedia.com/terms/n/npvgo.asp#:~:text=The%20net%20present%20value%20of%20growth%20opportunities%20(NPVGO)%20is%20a,new%20projects%20or%20potential%20acquisitions.