Salem Co. is considering a project that yields annual net cash inflows of $420,000 for years 1 through 5, and a net cash inflow of $100,000 in year 6. The project will require an initial investment of $1,800,000. Salem’s cost of capital is 10%.
Present value information is presented below:
Present value of $1 for 5 years at 10% is 0.62.
Present value of $1 for 6 years at 10% is 0.56.
Present value of an annuity of $1 for 5 years at 10% is 3.79.
What was Salem’s expected net present value for this project?
Net present value is a measure of the projected return on investment that accounts for the time value of money. It is the difference between the present value of future cash inflows from an investment and the costs related to the investment, including the investment's initial cost.
Using a 10% interest rate, the present value of an annuity of $420,000 a year for five years is $420,000 × 3.79, or $1,591,800.
The present value of a single payment of $100,000 in six years is $100,000 × 0.56, or $56,000.
These sum to a present value of future cash inflows of $1,647,800.
The net present value is this sum ($1,647,800) less the original investment of $1,800,000.
The difference is a negative net present value of $152,200.