QUESTION 1 Not complete Points out of 300 Flag question Payback Period, IRR, and

Question

QUESTION 1 Not complete Points out of 300 Flag question Payback Period, IRR, and Minimum Cash Flows The management of Mesquite Limited is currently evaluating the following investment proposal: Time 0 Year 1 Year 2 Year 3 Year 4 Initial investment $270,000 Net operating cash inflows -$100,000 $100,000 $100,000 $100,000 (a) Determine the proposal's payback period. years (b) Determine the proposal's internal rate of return. (Refer to Appendix 12B if you use the table approach.) (c) Given the amount of the initial investment, determine the minimum annual net cash inflows required to obtain an internal rate of return of 10 percent. Round the answer to the nearest dollar. Check

Explanation / Answer

(a) Payback period in case of even cashflows = Initial Investment / Annual cashflow

= 270000 / 100000 = 2.7 years

(b) Internal rate of return (IRR) is the rate at which Present value of cash inflow is equal to the Initial cash outflow i.e. Net Present Value is zero.

Let interest rate be 10%

NPV = 100,000 * PVAF (10%, 4 years) - 270,000

= 100000 * (0.909 + 0.826 + 0.751 + 0.683) - 270000 = 46,900

Let interest rate be 12%

NPV = 100000 * PVAF (12%, 4 years) - 270000

= 100,000 * (0.893 + 0.797 + 0.712 + 0.635) - 270000 = 33,700

(c) Calculation of Minimum amount cash inflows to obtain IRR of 10%. Let Annual minimum cash inflow be x.

At IRR, NPV = 0 i.e. PV of cash inflows = PV of cash outflows

x * PVAF (10% , 4 years ) = 270000

Thus, x = 270000 / 3.169 i.e x = 85,200.379 or 85,200 (approx).

Internal Rate Return = Lower discount rate + NPV (Lower discount rate) * (Higher rate - lower rate) (IRR) NPV (Lower discount rate) - NPV (Higher Discount Rate)

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