You are considering a an investment in a project with a life of eight years, an
ID: 2383523 • Letter: Y
Question
You are considering a an investment in a project with a life of eight years, an initial outlay of $120,000, and annual after-tax cash flow of $52,000. The project also requires an increase in inventories of $22,000. This $22,000 investment in inventory is required at the outset of the project and will be released when the project is completed. The appropriate discount factor for this project is 10 percent.
A. Calculate the payback period for this project assuming cash flows are evenly distributed across the year to two places of significance.
B. Calculate the discounted payback period for this project.
C. The firm has a required payback period of three years for both payback and discounted payback. What do your calculations in parts a and b suggest regarding the projects acceptability?
D. Calculate the NPV of this project. Based on your answer should the project be accepted? Explain.
E. Calculate the internal rate of return (IRR) for this project. Based on your answer should the project be accepted? Explain.
F. Calculate the profitability index for this project. Based on your answer should the project be accepted? Explain.
Explanation / Answer
Year 0, initial investment = $(120,000 + 22,000) = $142,000
Year 8, Cash inflow = $(52,000 + 22,000) = $74,000
(a) PBP
PBP CALCULATION
Year
Cash Flow
Cumulative Cash Flow
0
-1,42,000
-1,42,000
1
52,000
-90,000
2
52,000
-38,000
3
52,000
14,000
4
52,000
66,000
5
52,000
1,18,000
6
52,000
1,70,000
7
52,000
2,22,000
8
74,000
2,96,000
It is seen that PBP falls between years 2 & 3.
PBP = 2 + (Absolute cumulative cash flow, year 2 / Annual cash flow, year 3)
= 2 + $(38,000 / 52,000) = 2.73 years
(b) Discounted PBP
DISCOUNTED PBP CALCULATION
Year
Cash Flow
Discount Factor @10%
Discounted Cash Flow
Cumulative Discounted Cash Flow
0
-1,42,000
1.0000
-1,42,000
-1,42,000
1
52,000
0.9091
47,273
-94,727
2
52,000
0.8264
42,975
-51,752
3
52,000
0.7513
39,068
-12,684
4
52,000
0.6830
35,517
22,833
5
52,000
0.6209
32,288
55,121
6
52,000
0.5645
29,353
84,474
7
52,000
0.5132
26,684
1,11,158
8
74,000
0.4665
34,522
1,45,679
It is seen that discounted PBP falls between years 3 & 4.
Discounted PBP = 3 + (Absolute cumulative cash flow, year 3 / Annual cash flow, year 4)
= 3 + $(12,684 / 35,517) = 3.36 years
(c) If cutoff period is 3 years, then payback period indicates project acceptance, since PBP < Cutoff period. But discounted PBP is higher than the cutoff period and so project should be rejected based on this criterion.
(d) NPV
NPV CALCULATIONS
Year
Cash Flow
Discount Factor @10%
Discounted Cash Flow
0
-1,42,000
1.0000
-1,42,000
1
52,000
0.9091
47,273
2
52,000
0.8264
42,975
3
52,000
0.7513
39,068
4
52,000
0.6830
35,517
5
52,000
0.6209
32,288
6
52,000
0.5645
29,353
7
52,000
0.5132
26,684
8
74,000
0.4665
34,522
NPV
1,45,679
(e) IRR
Using the Excel =IRR function, the IRR compulation is as shown.
IRR CALCULATION
Year
Cash Flow
0
-1,42,000
1
52,000
2
52,000
3
52,000
4
52,000
5
52,000
6
52,000
7
52,000
8
74,000
IRR
33.51%
(f) Profitability Index
Year
Cash Flow
Discount Factor @10%
Discounted Cash Flow
0
-1,42,000
1.0000
-1,42,000
1
52,000
0.9091
47,273
2
52,000
0.8264
42,975
3
52,000
0.7513
39,068
4
52,000
0.6830
35,517
5
52,000
0.6209
32,288
6
52,000
0.5645
29,353
7
52,000
0.5132
26,684
8
74,000
0.4665
34,522
PV Of Future Cash Inflows
2,87,679
PI = Present value of future cash inflows / Initial Investment
= $287,679 / $142,000 = 2.02
Since PI > 1, the project should be accepted.
PBP CALCULATION
Year
Cash Flow
Cumulative Cash Flow
0
-1,42,000
-1,42,000
1
52,000
-90,000
2
52,000
-38,000
3
52,000
14,000
4
52,000
66,000
5
52,000
1,18,000
6
52,000
1,70,000
7
52,000
2,22,000
8
74,000
2,96,000
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.