Calculations of future cash flows


Problem:

Magnificent Modems, Inc. (MMI), has several capital investment opportunities. The term, expected annual cash inflows, and the cost of each opportunity are outlined in the following table. MMI has established the desired rate of return of 16 percent for these investment opportunities.

Opportunity                     A             B             C             D
Investment term          4 years    5 years    3 years     5 years
Expected cash inflow    $ 6,000    $ 5,000     $ 8,000     $ 4,800
Cost of investment      $16,000    $15,000    $18,000    $16,000

Required

a. Compute the net present value of each investment opportunity manually using the present value tables. Record your answers in the following table. The results for Investment Opportunity A have been recorded in the table as an example.

Opportunity                         A                B                C                 D
Cash inflow                   $6,000.00    $5,000.00    $8,000.00      $4,800.00

Times present value factor    $2.798181
Present value of cash flows    $16,789.09
Minus cost of investment    ($16,000.00)    ($15,000.00) ($18,000.00) ($16,000.00)
Net present value $789.09

b. Use Excel spreadsheet software or a financial calculator to determine the net present value and the internal rate of return for each investment opportunity. Record the results in the following table. The results for investment Opportunity A have been recorded in the following table as an example. Note that the manual computation yields the same net present value amounts as the financial function routines of Excel or a financial calculator.

Opportunity A B C D
Net present value $789.09
Internal rate of return 18.45%

c. What is meant by the expression, time value of money? Why should all capital investment proposals include time value of money (present value) calculations of future cash flows that are to be received from the alternative investments?

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Finance Basics: Calculations of future cash flows
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