There are 3 questions, I really appreciate your help!! 1. Elysian Fields, Inc. u
ID: 1170476 • Letter: T
Question
There are 3 questions, I really appreciate your help!!
1. Elysian Fields, Inc. uses a maximum payback period of 6 years and currently must choose between two mutually exclusive projects. Project Hydrogen requires initial outlay of $27,000; Project Helium requires an initial outlay of $34,000. Using the expected cash inflows given for each project in the following table, calculate each projects payback period. Which project meets Elysian’s Standards
Year
Hydrogen
Helium
1
$6,000
$7,500
2
$6,000
$7,000
3
$8,000
$8,000
4
$3,500
$6,000
5
$2,500
$4,500
6
$2,500
$4,000
2. Herky Foods is considering acquisition of a new wrapping machine. The initial investment is estimated at $1.08 million, and the machine will have a 5-year life with no salvage value. Using a discount rate of 5%, determine the net present value (NPV) of the machine given its expected operating cash inflows shown in the following table. Basd on the projects NPV, should Herky make this investment?
Year
Cash Inflow
1
$345,600
2
$324,00
3
$259,200
4
$302,400
5
$172,800
3. Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and choose between two alternatives. The first machine requires an initial investment of $39,000 and generates annual after-tax cash inflows of $8,000 for each of the next 9 years. The second machine requires an initial investment of $13,000 and provides an annual cash inflow after taxes of $3,000 for 22 years.
??Determine the payback period for each machine.??
??Comment on the acceptability of the? machines, assuming that they are independent projects.
??Which machine should the firm? accept? Why?
??Do the machines in this problem illustrate any of the weaknesses of using? payback?
Year
Hydrogen
Helium
1
$6,000
$7,500
2
$6,000
$7,000
3
$8,000
$8,000
4
$3,500
$6,000
5
$2,500
$4,500
6
$2,500
$4,000
Explanation / Answer
QUESTION 1
Payback period is the time taken to re-earn the invested amount.
Now, for the two projects give. Let us calculate the payback period for each:
Project Hydrogen:
Initial cashlfow = $27,000
From year 1 till year 5, the amount of cash inflows = $6000 + $6000 + $8000 + $3500 + $2500 = $26,000. Now $1000 more is needed to re-earn invested amount of $27000. But Year 6 cashflow is $2500.
So, by extrapolation, fraction of year 6 taken to re-earn $1000 = $1000/$2500 = 0.4 Year
Hence total payback for Hydrogen = 5 + 0.4 years = 5.4 years
Project Helium:
Initial cashlfow = $34,000
From year 1 till year 5, the amount of cash inflows = $7500 + $7000 + $8000 + $6000 + $4500 = $33,000. Now $1000 more is needed to re-earn invested amount of $34000. But Year 6 cashflow is $4000.
So, by extrapolation, fraction of year 6 taken to re-earn $1000 = $1000/$4000 = 0.25 Year
Hence total payback for Hydrogen = 5 + 0.25 years = 5.25 years
Both the projects since have payback of less than 6 years, meet standards set by company. Since payback period of Helium is low, that should be preferred investment.
QUESTION 2
Net present value is the sum of present values of all cash inflows and outflows, where all cashflows are discounted to the present using required rate of return.
Year
Cashflow
Discounted Cashflow @ 5%
0
-1080000
= -1080000/(1 + 0.05)^0 = -1080000
1
345600
= 345600/(1 + 0.05)^1 = 329142.9
2
324000
= 324000/(1 + 0.05)^2 = 293877.6
3
259200
= 259200/(1 + 0.05)^3 = 223906.7
4
302400
= 302400/(1 + 0.05)^4 = 248785.2
5
172800
= 172800/(1 + 0.05)^5 = 135393.3
NPV of the project is sum of all the discounted cashflows = $151,105.66
A positive NPV means a project would add value to the firm and its’ shareholders. Hence, it can be pursued.
QUESTION 3
Calculating payback periods for each of the two projects:
Purchasing machine 1 worth $39,000
For each year this project would generate $8000 for 9 years.
In 4 years, it would earn $8000 * 4 = $32,000. They would further need $7000 only to have the payback.
Fraction of year required to earn $7000 = $7000/$8000 = 0.875
Hence, overall payback = 4.875 years
Purchasing machine 1 worth $13,000
For each year this project would generate $3000 for 22 years.
In 4 years, it would earn $3000 * 4 = $12,000. They would further need $1000 only to have the payback.
Fraction of year required to earn $1000 = $1000/$3000 = 0.33
Hence, overall payback = 4.33 years
Given both are independent projects and have payback less than the limit of 5 year set by firm, both can be selected.
However, payback of project 2 is better and hence that should be prioritized.
However, the major disadvantage of using payback is that it does not accounts for time value of money or risk associated with a project. Project 2 could be higher risk project and hence the risk adjusted return of the project might be lower.
Year
Cashflow
Discounted Cashflow @ 5%
0
-1080000
= -1080000/(1 + 0.05)^0 = -1080000
1
345600
= 345600/(1 + 0.05)^1 = 329142.9
2
324000
= 324000/(1 + 0.05)^2 = 293877.6
3
259200
= 259200/(1 + 0.05)^3 = 223906.7
4
302400
= 302400/(1 + 0.05)^4 = 248785.2
5
172800
= 172800/(1 + 0.05)^5 = 135393.3
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