Company has obtained the following data about a possible planned investment: Cos

Question

Company has obtained the following data about a possible planned investment:

Cost $270,000

Terminal salvage value in 8 years $10,000

Additional annual revenues for 8 years $250,000

Additional annual cash expenses for 8 years $200,000

Estimated useful life in years 8

Minimum desired rate of return 10%

Present value of ordinary annuity, 10%, 8 periods 5.3349

Present value of one, 10%, 8 periods 0.4665

The company uses straight-line depreciation method. Ignore income taxes. Required:

A) Compute the net present value of the investment.

B) Compute the payback period.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Initial Investment = -270000

Annual Cash Inflows = (Additional Revenues - Additional Cash Expenses - Depreciation)*(1-Tax Rate) + Depreciation = (250000 - 200000 - (270000 - 10000)/8)*(1-0) + (270000-10000)/8 = 50000

NPV = -270000 + 67500*PVIFA(10%,8) + 50000*PVIF(10%,8) = -270000 + 50000*5.3349 + 10000*.4665 = 1410

Part B:

Payback Period

The total Investment of 270000 will get recovered as follows:

Year 1 Cash Inflow = 50000

Year 2 Cash Inflow = 50000

Year 3 Cash Inflow = 50000

Year 4 Cash Inflow = 50000

Year 5 Cash Inflow = 50000

and the balance value of 270000 - 250000 = 20000 between Year 4 and 5

Payback Period = 5 + 20000/(50000) = 5.4 Years

Since, the total initial investment 270000 with get recovered in full by the 5.4 th year, we will take the payback period as 5.4 Years

Payback Period = 5.4 Years

Thanks.

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