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9-5 Economic Profit and NPV

Steele Electronics is considering an investment in a new component that requires $100,000 investment in new capital equipment, as well as additional net working capital. The investment is expected to provide cash flows over the next five years. The anticipated earnings and project free cash flows for the investment are found in the table.

a) Assuming a project cost of capital of 11.24%, calculate the project's NPV and IRR.
b) Steele is considering the adoption of economic profit as a performance evaluation tool. Calculate the project's annual economic profit using the invested capital figures found in the table. How are your economic profit estimates related to the projects NPV?
c) How would your assessment of the project's worth be affected if the economic profits in 2006 and 2007 were both negative (no calculations required).

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This solution offers economic profit estimates.

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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