MBS Manufacturing is considering acquiring a small competitor. The purchase price is $5,000,000, which they would pay upfront in cash. They estimate the annual profit over the next 3 years to be $1,250,000 in year 1; $ 1,500,000 in year 2; $2,300,000 in year 3. While they expect to own the company for at least 5 years, MBS economic and finance departments apply a Net Present Value analysis using a 3-year time frame to assess profitability.

Their WACC is 8%

The 8% discount factors are:

Year 1, .925; Year 2, .857; Year 3, .793

Question:

Calculate the value of the discounted cash flows and determine the NPV

Based on the NPV analysis, is this a profitable investment; why or why not?

What risks/assumptions are there when relying on NPV analysis?

How can one adjust for those risks when calculating NPV?

What are the pros and cons of using a 3-year analysis?