The Great Eastern Toys Company is evaluating a new product. The cash flows are e

Question

The Great Eastern Toys Company is evaluating a new product. The cash flows are expected from this product over its five years' expected life are shown Note that the final years cash flow includes $2,000 of working capital to be re ered at the end of the project. 10. Investment criteria. recov. Now End-of-Year 1 to 4 End-of Year S Cash Flow -$18,000 5,200 7,200 a. Compute the following measures: 1. Payback period 2. Discounted payback period at a 10 percent discount rate 3. Net present value at a 10 percent discount rate 4. Internal rate of return 5. Profitability index b. Should the project be undertaken?

Explanation / Answer

(1) payback period

it is simple in 3 yrs you can earn 15600 ( 5200*3)

hence inflow requires for 4 the year for payback is 2400 ( 18000-15600)

now put equation that 5200 = 12 months

therefore. 2400= how many months ?

2400*12/5200 =5.54 months

therefore payback period = 3 yrs and 5.54 months

(2) discount pay back

step 1 caln of discounted cash flow and cumulative disc cash flow

5200 * 0.909 = 4726.8. 4726.8

5200 * 0.826 = 4295.2. 9022

5200 * 0.751 = 3905. 12927

5200 * 0.683 = 3551. 16478

7200 * 0.621 = 4471. 20949

upto 4 yrs you can earn 16478 therefore remaining earning requires is = 1522 ( 18000-16478)

we will put same equation as above for 5 the yr in this case 4471 = 12 months

therefore 1522= howmany months?

1522*12/4471 = 4.08 months

therefore disc pay back = 4 yrs and 4.08 months

(3) npv

= p.v of inflow - initial investment

= 20949( as calculated above ) - 18000

=2949

(4) internal rate of return where npv = zero

you can use trial and error method

?lets say first assume irr = 15% then in such case npv = 425

  now llet's say irr = 16% then npv = ( 21)

now put equation 1% change = 446 change in npv

therefore how many % ? = 21 change in npv

21*1/446 = 0.047

?ttherefore irr = 16 - 0.047 = 15.95%

if you will calculate npv @ 15.95% your npv will be 0

(5) profitability index = pv of inflow / pv of outflow

   = 20949/18000

   = 1.16

(b) yes project should be undertaken as npv is positive

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