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Capital Budgetingintermediate
NPV Two-Year Project
Evaluate a short project with NPV and make an accept/reject decision.
Problem Scenario
Initial outlay is $1,000. Year 1 inflow is $600 and year 2 is $650. Discount rate is 9%.
Given Data
Initial$1,000
Year 1$600
Year 2$650
Rate9%
Requirements
- Compute NPV
- State accept/reject
Solution
Step 1:
Discount year 1: 600/1.09 = 550.46.
Step 2:
Discount year 2: 650/(1.09)^2 = 650/1.1881 = 547.10.
Step 3:
NPV = 550.46 + 547.10 - 1000 = 97.56.
Final Answer
NPV ≈ $97.56. Accept because NPV > 0.
Key Takeaways
- ✓NPV > 0 implies value creation
- ✓Always discount each cash flow separately
Common Errors to Avoid
- ✗Forgetting to discount year-2 cash flow by two periods
- ✗Omitting the initial outflow
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Common questions about this problem type
For class decisions, prioritize NPV.
Discount each cash flow individually at the required rate. You cannot use the annuity formula when cash flows differ across periods.