Each of the following scenarios is independent. Assume that all cash ?ows are af

ID: 2630256 • Letter: E

Question

Each of the following scenarios is independent. Assume that all cash ?ows are after-tax cash ?ows. a. Colby Hepworth has just invested $400,000 in a book and video store. She expects to receive a cash income of $120,000 per year from the investment. b. Kylie Sorensen has just invested $1,400,000 in a new biomedical technology. She expects to receive the following cash ?ows over the next ?ve years: $350,000, $490,000, $700,000, $420,000, and $280,000. c. Carsen Nabors invested in a project that has a payback period of four years. The project brings in $960,000 per year. d. Rahn Booth invested $1,300,000 in a project that pays him an even amount per year for ?ve years. The payback period is 2.5 years. Required: 1. What is the payback period for Colby? 2. What is the payback period for Kylie? 3. How much did Carsen invest in the project? 4. How much cash does Rahn receive each year?

Explanation / Answer

Amount invested=400000

Cash flow per year =120000

Since the cash flows generated are equal throughout the period hence payback period can be calculated as

Payback period= Amount invested/Cash flow per year= 400000/120000=3.33

2.Payback period for kylie:

Amount invested=1400000

Cash flows:

Year

Cash flow

Cumulative cash flow

350000

490000

840000

700000

1540000

420000

1960000

280000

2240000

Since the cash flow is not equal throughout hence payback is calculated as under:

Payback period is when the cumulative cash flow >= amount invested in proportion

Here amount invested is regained during the 2nd to 3rd year. Hence payback period will be 2 years and x months.

These x months are a proportion of the cash flow during that year = (1400000-840000)/(1540000-840000)

=0.8

Hence payback period=2.8 years

3.Carsen invested :

Amount of investment= no of years *cash flow per year = 4*960000=3840000

4.Amount of cash received by rahn each year:

Amount invested= 1300000

Payback period =2.5 years

Since the cash flows from the project is equal thrpughout hence amount of cash received by Rahn each year= Amount invested/ Payback period= 1300000/2.5= 520000