1. Suppose Palmer Properties is considering investing $2.6 million today (i.e.,

Question

1. Suppose Palmer Properties is considering investing $2.6 million today (i.e., C0 = -2,600,000) on a new project that is expected to last for 7 years. The project is expected to generate annual cash flows of C1 = -250,000; C2 = 300,000, C3 = 500,000 and then $800,000 for period C4 through C7. If the discount rate is 8% and management’s payback period cutoff is 5 years:

            (a) What is the payback period for the project? Show your work

            (b) What is the net present value of the project ? Show your work

            (c) What is the internal rate of return on the project ? Show your work

            (d) Under which method(s) above should the company accept the project (applying the acceptance rules)? Explain

Explanation / Answer

a)

PAYBACK PERIOD=E+B/C

WHERE

E=NO OF YEARS IMMEDIATELY PRECEDING THE YEAR OF RECOVERY

B=BALANCE OF AMOUNT OF INVESTMENT TO BE RECOVERED

C=SAVINGS DURING THE YEAR OF FINAL RECOVERY

PAYBACK PERIOD=5+(2600000-2150000)/800000

=5+.5625X12 MOTNTHS

=5 YEAR 6.75 MONTH

B)

NPV

total 2525800

less cash outflow 2600000

npv = -74200

c)I.R.R=LOWER RATE+(P.V AT LOWER RATE -P.V.F)/DIFF IN CALCULATED PRESENT VALUEX DIFF IN RATE

TOTAL 2778450

LESS CO 2600000

178450

IRR= 6 +178450/252650(8-6)

= 6+1.4

=7.4%

D) COMPANY SHOULD NOT ACCEPT THE PROJECT AS THE PAYBACK PERIOD IS MORE, NPV IS NEGATIVE AND INTERAL RATE OF RETURN IS LESS AS STATED.

year cash flow cumulative cash flow c1 -250000 -250000 C2 300000 -250000+300000=50000 C3 500000 500000+50000=550000 C4 800000 550000+800000=1350000 C5 800000 1350000+800000=2150000 C6 800000 2150000+800000=2950000 C7 800000

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