Question 1. Capital Budgeting
Part 1. NPV
You have an opportunity to invest in a start-up firm. The start-up will require an initial investment of $225,000 at the present (year/time 0). After the initial investment, the startup firm is expected to generate $52,000 per year in cash flows for three years (i.e., from year 1 to year 3). In year 4, you anticipate selling the start-up firm for $365,000 (i.e. you will receive cash flow of $365,000 in year 4). Based on the above information, calculate the NPV of the start-up firm and discuss whether you should invest in the start-up firm. Assume a 10.5% opportunity cost of capital.
Part 2. IRR
You have an opportunity to invest in a start-up firm. The start-up will require an initial investment of $225,000 at the present (year/time 0). After the initial investment, the startup firm is expected to generate $52,000 per year in cash flows for three years (i.e., from year 1 to year 3). In year 4, you anticipate selling the start-up firm for $365,000 (i.e. you will receive cash flow of $365,000 in year 4). Based on the above information, calculate the IRR of the start-up firm and discuss whether you should invest in the start-up firm. Assume a 10.5% opportunity cost of capital. Hint: You can use our Excel model at Blackboard to compute IRR problem.