Questions on the Net Present Value - Essay Example

The NPV of both projects are negative; that is why, they do not meet the minimum standard for Big LU investments.

The payback period of Alpha = 8.0 years; and the payback period of Zeta = 7.1 years. The rate of return of Alpha = 12.50%; and the rate of return of Zeta= 14%.

NPV of the project Alpha = -$64,343,913; and NPV of the project Zeta = -$120,162,957.

The formula is NPV = - Initial investment + sum of discounted values of each year's net cash flow during the project life. The NPV takes care of; initial investment, cost of capital, and income generated by the project. If two projects are mutually exclusive, then Big Lu should invest in the project with the larger value of NPV. 

If two projects are not mutually exclusive, Big Lu rejects the project with the negative NPV and accepts the one with the positive NPV.

The concept breakeven point implies when NPV =0. For Project Alpha, it means that the sum of all discounted values of an annual income of each year ($25,000,000) becomes equal to $200,000,000. The equation for the break-even point with the consideration of NPV is expressed as, 0 = -$200,000,000 + (Sum of all PV Factors) x $25,000,000 (“Definition of Net Present Value”). From this equation, the Sum of all PV Factors = 200,000,000 / 25,000,000 = 8. The PV Factor for each year is calculated using the formula, 1/(1+r)^n. In this formula, r = 13%, and n = number of years, such as 1,2,3 ……., and so on. The sum of PV factors at r = 13% for 70 years is equal to 7.69, and NPV = -7,721,304. It can be concluded that the Break-even point with NPV for the Alpha project is much longer than 70 years. The sum of all PV Factors for the project Zeta is calculated, Sum of all PV Factors = 500,000,000 / 70,000,000 = 7.1428. The sum of all PV Factors for the yearly return of 13% in 25 years is equal to 7.1695. It is concluded that the Break-even points of the Zeta project are between 24 and 25 years.