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Evaluating Projects Using NPV

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A firm is considering the adoption of a project that is expected to generate revenues for 10 years. These expected revenues (in dollars) are:

Year 1: $200,000 Year 6: $270,000
Year 2: 250,000 Year 7: 255,000
Year 3: 300,000 Year 8: 240,000
Year 4: 300,000 Year 9: 150,000
Year 5: 280,000 Year 10: 75,000

The total cost of the project, to be paid immediately upon adoption, is $1.6 million. Use a spreadsheet to compute the net present value of the project if:

A. The firm's cost of capital is 6 percent. Should the project be adopted?

B. The firm's cost of capital is 8 percent. Should the project be adopted?

Suppose the firm has a second project that requires an initial outlay of $800,000 and is expected to generate revenues for only five years, and those revenues are of the same amounts as given above for years 1 to 5. Use the same spreadsheet to compute the net present value of this project if:

C. The firm's cost of capital is 6 percent. Is this project one that the firm would like to adopt?

If these are the only two projects that the firm is contemplating, what should the firm do if:

D. Its capital budget is $1 million and its cost of capital is 6 percent?
E. Its capital budget is $3 million and its cost of capital is 6 percent?

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The solution evaluates projects using NPV.

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