1. Suppose Palmer Properties is considering investing $2.6 million today (i.e.,
ID: 2714328 • Letter: 1
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
Computation of payback period
Years Cashflows Cummulative cash flows
1 - 250000 (250000)
2 300000 50000
3 500000 550000
4 800000 1350000
5 800000 2150000
6 800000 2950000
7 800000 3750000
Pay back period = 5 + 450000 / 750000
= 5 + 0.6 = 5.6
b. Computation of net present value
Year Cash inflows Discount@ 8% PV cash inflows
1 - 250000 0.926 (231500)
2 300000 0.857 257100
3 500000 0.794 397000
4 800000 0.735 588000
5 800000 0.681 544800
6 800000 0.630 504000
7 800000 0.584 467200
Total PV cash inflows 2526600
less : initial investment (2600000)
NPV (73400)
C. Computation of IRR
Year cash inflows discount @10% PV cash inflows
1 - 250000 .909 (227250)
2 300000 .826 247800
3 500000 .751 375500
4 800000 .683 546400
5 800000 .621 496800
6 800000 .565 452000
7 800000 . 513 410400
Totl PV cash inflows 2301650
less: initial investment 2600000
NPV (298350)
IRR = lower rate + NPV lower rate / NPV lower rate - NPV higher rate * difference factor
= 8 + -73400 / (-73400 + 298350 ) * 2
= 8 - 0.656
= 7.34%
d. Pay back period is rejected, because pay back period is greater than cutoff period so, it is rejected.
NPV has rejected, because NPV has negative value
IRR is that discounting rate 7.34% at which NPV of the project is zero . so it can be accepted.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.