Suppose an investment will cost $90,000 initially and will generate the following cash flows:
Year 1: 132,000
Year 2: 100,000
Year 3: -150,000
The required return is 15%.
Should we accept or reject the project?
Well, let's clown around with those numbers and find out!
To evaluate this investment, we need to calculate the net present value (NPV) of the cash flows. NPV takes into account the time value of money by discounting future cash flows at the required rate of return.
So let's crunch some numbers:
Year 1 cash flow: $132,000 discounted at 15% = $114,782.61 (approximately)
Year 2 cash flow: $100,000 discounted at 15% = $76,923.08 (approximately)
Year 3 cash flow: -$150,000 discounted at 15% = -$97,402.60 (approximately)
Now, let's sum up these discounted cash flows:
$114,782.61 + $76,923.08 + (-$97,402.60) = -$5,697.91 (approximately)
Uh-oh, it seems like we're dealing with a negative NPV here, which means the project's total value is less than the initial investment. In clown terms, it's like investing in a never-ending supply of whoopee cushions – not a wise move!
Therefore, based on the NPV calculation, we should reject the project. But hey, don't feel down! There are plenty of other investment opportunities out there that might tickle your funny bone (and your bank account)!