Q13SE - Horngren'S Financial And Managerial Accounting

Question

Refer to Short Exercise S26-4. Assume the expansion has no residual value. What is the project’s NPV (round to nearest dollar)? Is the investment attractive? Why or why not?

Step-by-Step Solution

Answer

The investment is attractive and the net present value is $2,215,432.21.

Step 1: Definition of Net Present Value

A metric that determines the present value of all the stream of cash inflows that will be received in the future period of time is known as net present value. It is also used in capital budgeting.

Step 2: Analysis of Project using NPV

Time	Particular	Net cash inflow	Ordinary annuity PV factor	PV factor	Present value
1-7years	PV of annuity	$2,714,756	4.868	-	$13,215,432.21
Total PV of net cash flow
					$13,215,432.21
0	Initial investment				($11,000,000)
Net present value of the project					$2,215,432.21

Note: The project’s net present value is positive; therefore, the investment is attractive. 

Working note:

$\begin{array}{rcl}Average annual net cash flow& =& \left(\begin{array}{c}Number of additional skiers\times Average number of days allow sking\times \\ \left(Average cash spent by skier-Average variable cost per skier\right)\end{array}\right)\\ & =& \left(121\times 142(\$241-\$83)\right)\\ & =& \$2,714,756\end{array}$