Chapter 9 Capital Budgeting Problem 20 points Laura Corporation is considering t

Question

Chapter 9 Capital Budgeting Problem
20 points


Laura Corporation is considering the purchase of new equipment with a cost of $41,000. The expected cash inflow from the use of this equipment is $10,000 per year of the next five years. The required rate of return is 10 percent.


1. Calculate the payback period (4 points).

2. Calculate the Net Present Value (6 points).

3. Calculate the Internal Rate of Return (6 points).

4. Would you advise Laura Corporation to purchase the equipment? Explain your answer (4 points).

Explanation / Answer

1. Payback period = 4.1 years
Payback period = # of years before full recovery + (remaning cash flow in the year of full recovery / cash flow in the year of full recovery)
= 4 + (1000/10000) = 4.10

2. NPV = -2811.03
NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2.......CFn/(1+r)n . Using this formula we get NPV = -2811.03. This can also be calculated using the cash flow function in a financial calculator or using excel.

3. IRR = 7%

IRR is the rate at which NPV is zero. Thuss IRR can be found using the estimation process using the above formula. OR IRR can be found using financial calculator by inputtting the below values:

-41000 = CFj; 10000 = CFj; 10000 = CFj; 10000 = CFj; 10000 = CFj; 10000 = CFj. Now compute for IRR.

4. This is not a good project and we will advice Laura Corp not to purchase the equipement since the NPV is negative and the IRR is less than the required rate of return.

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