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25 September, 14:53

Fijisawa Inc. is considering a major expansion of its product line and has estimated the following free cash flows associated with such an expansion. The initial outlay would be $1,800,000 , and the project would generate incremental free cash flows of $600,000 per year for 5 years. The appropriate required rate of return is 8 percent. a. Calculate the NPV.

b. Calculate the PI.

c. Calculate the IRR.

d. Should this project be accepted?

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  1. 25 September, 15:27
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    a.)

    Using Financial calculator, enter the following CFs to find NPV;

    CF0 = - 1,800,000

    C01 = 600,000

    C02 = 600,000

    C03 = 600,000

    C04 = 600,000

    C05 = 600,000

    Interest rate (I) = 8%

    CPT NPV = $595,626.02

    b.)

    Profitability Index (PI)

    PI = NPV of cash inflows / Initial outlay

    Using Financial calculator, enter the following CFs;

    Find the NPV of the expected future cash inflows;

    CF0 = 0

    C01 = 600,000

    C02 = 600,000

    C03 = 600,000

    C04 = 600,000

    C05 = 600,000

    Interest rate (I) = 8%

    NPV = $2,395,626.02

    PI = $2,395,626.02/1,800,000 = 1.331

    c.)

    You can use a Financial calculator to find the IRR;

    CF0 = - 1,800,000

    C01 = 600,000

    C02 = 600,000

    C03 = 600,000

    C04 = 600,000

    C05 = 600,000

    CPT IRR = 19.86%

    d.)

    Based on the NPV rule, a company should accept a project if the NPV is greater than 0. This project's NPV of $595,626.02 meets this criteria, therefore, the project should be accepted.

    Based on IRR rule, a company should accept a project if the IRR of the project is greater than the cost of capital; which is also the required return. The IRR of this project is 19.86% which is significantly higher than the cost of capital of 8% hence in agreement that the project should be accepted. The Profitability Index is also greater than 1 hence the project should be accepted.
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