Question

List & identify formula for Net Present Value & Profitability Index

Answer 1

[To learn how to calculate present value(PV), be sure to read A Primer on Present Value and Its Many Uses]

Cost to purchase Company ABC today: $1,000,000

Present value (PV) of cash flows from acquiring Company ABC:

Year 1: $200,000

Year 2: $150,000

Year 3: $100,000

Year 4: $75,000

Year 5: $70,000

Year 6: $55,000

Year 7: $50,000

Year 8: $45,000

Year 9: $30,000

Year 10: $10,000

Total: $785,000

Now that we know the total cash flow for the next 10 years (the total cash inflows from the investment), along with total cost of the investment in Company ABC, we can use the formula to calculate NPV:

Net Present Value (NPV) = $785,000 - $1,000,000 = -$215,000

At this point, management for Company XYZ would use the net present value ruleto decide whether or not to pursue the acquisition of Company ABC. Because the NPV is negative, they should say, "No."