5. Payback, NPV, and IRR Rieger International is attempting to evaluate the feas

Question

5. Payback, NPV, and IRR Rieger International is attempting to evaluate the feasibility of investing $115,000 in a piece of equipment that has a 5-year life. The firm has estimated the cash inflows associated with the proposal as shown in the following table: 1. The firm has a 8% cost of capital. a. Calculate the payback period for the proposed investment. b. Calculate the net present value (NPV) for the proposed investment. c. Calculate the internal rate ofreturn (IRR), rounded to the nearest whole percent, for the proposed investment. d. Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project? years. (Round to two decimal places.) a. The payback period of the proposed investment is b. The NPV of the proposed investment is $ c. The IRR of the proposed investment is d. Should Rieger International accept or reject the proposed investment? (Select the best answer below.) . (Round to the nearest cent.) %. (Round to two decimal places.) O A. Accept O B. Reject 1: Data Table (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Cash inflows (CF) $40,000 $25,000 $40,000 $40,000 $20,000 Year (t) 2 4

Explanation / Answer

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a) Computation of Payback period Payback period (PP) is the number of years it takes for a company to recover its original investment in a project In the given case, Reiger International has the following cash flows: Total Outflow = $115,000 Year Cash Flows Payback period 1 $40,000 1 2 $25,000 2 3 $40,000 3 4 $40,000 5 $20,000 Till Year 3, total recovery was $(40000+25000+40000) = $105,000 Remaining recovery = $115000-105000 = $10,000 Payback period would be = 3 + (10000/40000) 3.25 years b) Computation of NPV PV of cash inflows Year Cash Flows PVIF (8%) PV 1 $40,000 0.926 $37,037 2 $25,000 0.857 $21,433 3 $40,000 0.794 $31,753 4 $40,000 0.735 $29,401 5 $20,000 0.681 $13,612 3.993 $133,237 NPV = PV of cash inflows - Initial investment $(133,237 - 115,000) $18,237 c) Computation of IRR IRR is the interest rate at which the NPV of all the cash flows from a project equal zero Year Cash Flows PVIF(14.149%) PV 1 $40,000 0.876 $35,041.80 2 $25,000 0.767 $19,186.37 3 $40,000 0.672 $26,892.99 4 $40,000 0.589 $23,559.47

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$20,000 0.516 $10,319.58 $115,000.20 Cash Outflow $115,000.00 - Hence IRR is 14.15% Here, I have used trial error method which means plugging in random rate as IRR I have used rates between 14% and 15% which results in PVIF equal to Cash outflow d) Rieger Investment should accept the proposal since it favourable in both cases of NPV since it is positive ($18,237)and as well as IRR is more than cost of capital (14.15% Vs 8%)

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