A companyâ€™s growth and development, and indeed its ability to remain competitive and survive, depends upon a constant flow of new investment ideas. The most common and effective method used to evaluate investments in long-term projects is to determine each projectâ€™s net present value (NPV). The process of determining whether the future cash flow benefits arising from a long-term project are sufficient to justify the required up-front cash investment is also called capital budgeting. The net present value method uses a discount rate (interest rate) to restate all cash flows in terms of present values, and then makes comparisons on which project has the highest net present value.

In this project you are provided expected cash flows over the course of five years for two alternative long-term projects that XYZ Entertainment Company is considering investing in. XYZ will only invest in one of the projects. XYZ uses a discount rate (interest rate) of 18% to calculate the present value of future cash flows.

Use the XYZ cash flow projections below to complete your calculations for this project.

XYZ Long-Term Cash Flow Projection for Project A
Cash Investment at start of project (initial cash outflow) = ($1,000,000)

Year 1: Cash inflow = $350,000

Year 2: Cash inflow = $350,000

Year 3: Cash inflow = $350,000

Year 4: Cash inflow = $350,000

Year 5: Cash inflow = $350,000

XYZ Long-Term Cash Flow Projection for Project B
Cash Investment at start of project (initial cash outflow) = ($1,000,000)

Year 1: Cash inflow = $450,000

Year 2: Cash inflow = $500,000

Year 3: Cash inflow = $500,000

Year 4: Cash inflow = $150,000

Year 5: Cash inflow = $150,000

The formula to calculate the present value of each yearâ€™s future cash inflow is:

Present Value = Future Value / (1 + interest rate)Number of Years

Follow these steps to determine each projectâ€™s net present value (NPV):

1. Calculate the present value of the cash inflows for each of the 5 years.

2. Sum all 5 years of calculated present values.

3. Subtract the cash investment at the start of the project (initial cash outflow).

4. The result will be the projectsâ€™s net present value.

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Use XYZ Entertainment Companyâ€™s 5-year Cash Flow projections for Project A and Project B to complete the Project 3 Answer Sheet. Include the following information:

1. The net present value (NPV) of Project A

The present value of cash inflow for year 1
The present value of cash inflow for year 2
The present value of cash inflow for year 3
The present value of cash inflow for year 4
The present value of cash inflow for year 5

2. The net present value (NPV) of Project B

The present value of cash inflow for year 1
The present value of cash inflow for year 2
The present value of cash inflow for year 3
The present value of cash inflow for year 4
The present value of cash inflow for year 5

3. Which project has the highest net present value (Project A or Project B)?

A companyâ€™s growth and development, and indeed its ability to rem...