9 February, 11:39

# Your firm is considering opening a branch office in Kyle. The office would cost \$485,000 to build the office. During the office is expected to generate cash flows of \$45,000 during the first year of operation, \$120,000 the second year, then reach a steady cash flow of \$150,000 per year for the next three years. If your required return is 16%, should you open the branch office?

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1. 9 February, 13:01
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The NPV from opening the branch office is negative (-\$106668.08). Thus the branch office should not be opened.

Explanation:

The decision to open the branch office will be taken based on the NPV provided by opening of the branch office. If the NPV of a project is positive based on the required rate of return used as a discount rate fro cash flows, the investment is worth undertaking.

The net present value (NPV) for a project can be calculated as,

NPV = CF1 / (1+r) + CF2 / (1+r) ² + ... + CFn / (1+r) ^n - Initial Outlay

Where,

r is the appropriate discount rate Initial Outlay is the Initial cost of the project CF represents cash flows from the project

As the required return is 16%, we will take this as the appropriate discount rate.

NPV = 45000 / (1+0.16) + 120000 / (1+0.16) ² + 150000 / (1+0.16) ³ +

150000 / (1+0.16) ^4 + 150000 / (1+0.16) ^5 - 485000

NPV = - \$106668.08

As the NPV from project is negative at a required return of 16%, the project should not be under taken and the branch office should not be open.