NPV - How to calculate

Submitted by rahul178 on Tue, 06/14/2011 - 07:29

Question:

A construction company is considering constructing a 30-floor residential building in the centre of a city. It expects to spend $5m today and receive about $10m at the end of a year when the construction is finished and the apartments are sold out. The company is confident that all the apartments would be sold out by the end of a year.
What is the Net Present Value (NPV) of the project? Assume an inflation rate of 10%.

1. 13.63m
2. $4.1m
3. $9.1m
4. Cannot estimate with the given information

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varun.s

Tue, 06/14/2011 - 10:48

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PV of inflow at the end of

PV of inflow at the end of the year = 10/(1+0.1) = $9.09m

Present Outflow = $5m (its the outgoing money so subtracted)

NPV = (5)+9.09 = $4.09m

NOTE: The discount rate reflects the future value of money, it typically has two components: an adjustment for inflation, and a risk-adjusted return on the use of the money. Since market forces typically incorporate inflation adjustments into investment returns and borrowing costs, often the discount rate is keyed to a standard reference rate.

Here we are taking discount rate as the inflation rate (this somewhere makes me skeptical of considering D option into account)

Do share the author's thoughts