Cashflow: Which Present Worth

Suppose you have a net cash flow for a project of -10K in the first year and 20K in the second and net income of 3K and 5K respectively. Given a MARR of 5%, what is the relevant present worth?

Question options:

  • 7.76K
  • 8K
  • 9.05K
  • 10K

You have to be very careful with this question. Do not get confused on the fact that an increase on Net Income ($3,000 and $5,000 respectively) plays a determinant factor on present worth. In one hand, yes it does play a role since in the Income Statement the Net income value is calculated by taking the revenues and subtracting the expenses and depreciation. The value resulting from that algebraic sum is submitted to an income tax percentage, meaning that a percentage of the algebraic sum is taxes.

On the other hand, in the Cash Flow Statement that Net Income value (from the process described above) is added to the depreciation and that sum gives you the Net Cash Flow value that is used on the present worth (PW) formula.

Now, going back to the question above, it states that the Net Income increases in both periods (zero and one) by $5,000 and $3,000 respectively; however, this amount is relative. Although the increase is positive, the value is still dependent from the other variables (depreciation, revenues, expenses, etc.) which tells you that regardless of the increases in Net Income, there was a decrease of $10,000 in period 0 and an increase of $20,000 in period one of the Net Cash Flow . If you recall from above, is it the Net Cash Flow value the one that is used for PW formulas since that value is absolute for each period.

Doing the calculations:

PW(5%) = -10000(P/F,5%,0) + 20000(P/F,5%,1)
PW(5%) = $9,047.68

Therefore the correct answer is 9.05K

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