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15 May, 11:27

Brewster's is considering a project with a 5-year life and an initial cost of $120,000. The discount rate for the project is 12 percent. The firm expects to sell 2,100 units a year at a net cash flow per unit of $20. The firm will have the option to abandon this project after three years at which time it could sell the project for $50,000. The firm is interested in knowing how the project will perform if the sales forecasts for Years 4 and 5 of the project are revised such that there is a 50 percent chance the sales will be either 1,400 or 2,500 units a year. What is the net present value of this project given these revised sales forecasts

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  1. 15 May, 11:29
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    NPV = $27,792

    Explanation:

    Net Present Value = Present Value of Future Cash Flows - Initial Investments

    To compute the Present value of Future Cash Flows, we need to first compute the cash inflows during the life of the project:

    Year 1: 2,100 * 20 = $42,000

    Year 2: 2,100 * 20 = $42,000

    Year 3: 2,100 * 20 = $42,000

    The units of Year 4 and Year 5 are calculated as follows:

    ⇒ (0.5 * 1,400) + (0.5 * 2,500) = 1,950 units

    Year 4: 1,950 * 20 = $39,000

    Year 5: 1,950 * 20 = $39.000

    Now, discount the cash inflows at a rate of 12% to calculate the Present Value of Future Cash Flows

    ⇒ 42,000 + 42,000 + 42,000 + 39,000 + 39,000

    (1.12) ^1 (1.12) ^2 (1.12) ^3 (1.12) ^4 (1.12) ^5

    ⇒ 37,500 + 33,482 + 29,895 + 24,785 + 22,130

    ⇒ $147,792

    Net Present Value = Present Value of Future Cash Flows - Initial Investments

    NPV = 147,792 - 120,000

    NPV = $27,792
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