You are preparing to produce some goods for sale. You will sell them in one year and you will...

Question:

You are preparing to produce some goods for sale. You will sell them in one year and you will incur costs of $82,000 immediately.

If your cost of capital is 7.2%, what is the minimum dollar amount you need to sell the goods for in order for this to be a non-negative NPV?

Cost of Capital:

In capital budgeting, the cost of capital is the opportunity cost of funds that are used to finance a capital project. Thus, the cost of capital is also the appropriate discount rate for future cash flows when evaluating projects.

Answer and Explanation:

The net present value is the present value of cash inflows, minus the initial cost. We know the initial cost is 82,000, the cash flow is the sale value of the goods. The discount rate is the cost of capital, which is 7.2%. To have a non-negative NPV, we must have:

  • sales value / (1 + 7.2%) - 82,000 >= 0
  • sales value /(1 + 7.2%) >= 82,000
  • sales value >= 87,904

That is, the minimum sale value of the goods is $87,904.


Learn more about this topic:

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Evaluating a Budget Using the Net Present Value Method

from Accounting 301: Applied Managerial Accounting

Chapter 14 / Lesson 3
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