Homework SourseAnderson International Limited is evaluating a project in Er
Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:
All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 7 percent. Assume Anderson uses a required return of 12 percent on this project.
What is the NPV of the project?
| Year | Cash Flow |
| 0 | –$586,000 |
| 1 | 216,000 |
| 2 | 159,000 |
| 3 | 224,000 |
| 4 | 203,000 |
Solution
The NPV of the project is calculated as follows:
Since the funds are being reinvested at 7% and the rate of return is 12%, the effective discount rate is 12-7 =5%
The NPV calculation is as shown below:
| Year | Cash flow | Discounted Cash flow at 5% |
| 0 | -586000 | -586000 |
| 1 | 216000 | 205714.2857 |
| 2 | 159000 | 144217.6871 |
| 3 | 224000 | 193499.6221 |
| 4 | 203000 | 167008.6024 |
| NPV | $ 124,440.20 |
