NPV calculation error?

Question

If you are a zoo and you buy a new animal that is going to increase your current revenues (4.5M) by 8% (so as additional 360K)..when you do NPv, shouldn't the Net Op profit be New Revenues (I.e 4.5M+360K) - new costs? But the answer shows NPV calculation as (360K (I.e the additional revenue) - new costs)/discount rate - investment cost..why are they calculating new profit using just the additional revenue of 360K instead of 4.5M+360K? Is this correct?

Answer 1

NPV is calculated for 'a' project. In this case that project is 'buying an animal for the zoo'.

Hence, you will consider the elements relevant for the project only:

Revenue from the project --> Additional revenue (360k)
Running costs of the project ---> Additional new costs
Initial costs of the project --> cost of acquiring the animal
Profit from the project --> additional revenue minus additional running costs

Hope this explains.

Answer 2

Hi there,

This is not a case error at all!

The entire point of NPV is to evaluate the decision to buy the animal.

The zoo already makes $4.5M...the animal has no impact on this!

You can only measure the impact of the animal which is $360k....this is recurring revenue and so you apply NPV to understand what that $ amount is in today's dollars, so as to determine whether the upfront investment is worth it!

Answer 3

Your are eveluating a project so you should calculate the NPV of the project not of the overall company. The correct approach is always to use differntial cost, revenues and investments versus the status quo