Mega Dynamics is considering a project that has the following cash flows: Year Project Cash Flow
YEAR PROJECTED CASH FLOW
0 ?
1 2000
2 3000
3 3000
4 1500
The project has a payback of 2.5 years. The firm's cost of capital is 12 percent. What is the project's net present value (NPV)?
A) $765.91
B) $1,049.80
C) $2,761.32
D) $577.68
E) $3,765.91

The NPV of the project is $765.91 and option A is the correct answer.

Explanation:

To calculate the initial outlay or cost of the project, we will use the payback period of the project. The payback period is the time taken by the project's cash flows to cover up the initial cost.

A payback period of 2.5 years means that the initial cost was,

Initial cost = 2000 + 3000 + 3000 * 0.5

Initial cost = $6500

To calculate the NPV of the project, we use the following formula,

NPV = CF1 / (1+r)  +  CF2 / (1+r)^2  +  ...  +  CFn / (1+r)^n  -  Initial cost

Where,

NPV = 2000 / (1+0.12)  +  3000 / (1+0.12)^2  +  3000 / (1+0.12)^3  +  

1500 / (1+0.12)^4  -  6500

NPV = $765.9137794 rounded off to $765.91

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