Lecture problems – capital budgeting criteria
I Scream Ice Cream is considering an ad campaign that is expected to cost $500,000 today;
produce cash flows of $520,000 in 1 year, $0 in 2 years, $0 in 3 years, and X in 4 years; have
a required return of 10 percent; and have an NPV of $20,000.
What is X?
NPV = [C
0
] + [C
1
/ (1+r)] + [C
2
/ (1+r)
2
] + .
.. + [C
t
/ (1+r)
t
]
In this case,
20,000 = [-500,000] + [520,000 / 1.10] + [0 / 1.10
2
] + [0 / 1.10
3
] + [X / 1.10
4
]
= -500,000 + 472,727 + 0 + 0 + [X / 1.10
4
]
So 20,000 + 500,000 – 472,727 = X / 1.10
4
= 47,273 = X / 1.10
4
So X = 47,273 × 1.10
4
= $69,212.40 ≈ $69,212
The expected cash flow in 4 years (X) is $69,212
Confirm:
npv(10,-500000,{520000,0,0,69212})
20,000
☺
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