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20 December, 07:49

1. The owners of a chain of fast-food restaurants spend $25 million installing donut makers in all their restaurants. This is expected to increase cash flows by $11 million per year for the next five years. If the discount rate is 5.3%, were the owners correct in making the decision to install donut makers

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  1. 20 December, 07:57
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    The NPV is positive. The investment is good, therefore the owners made a correct investment decision

    Explanation:

    To determine whether or not the investment was right, we will need to determine the net present value of the investment (NPV).

    The NPV is the difference between the PV of cash inflows and the PV of cash outflows. A positive NPV implies a good investment decision and a negative figure implies the opposite.

    NPV of an investment:

    NPV = PV of Cash inflows - PV of cash outflow

    PV of annuity = 1 - (1+r) ^ (-n) / r * Annual cash flow

    PV of 11 million annuity for 5 years

    = (1 - (1.053) ^ (-5)) / 0.053) * 11,000,000

    = 4.2938 * 11,000,000

    = $47,231,874.4

    NPV of the investment

    = 47,231,874.4 - $25,000,000

    = $22,231,874.40

    The NPV is positive. The investment is good, therefore the owners made a correct investment decision.
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