Reynolds Enterprises is attempting to evaluate the feasibility of investing $85,

Question

Reynolds Enterprises is attempting to evaluate the feasibility of investing $85,000, CF0, in a machine having a 5-year life. The firm has estimated the cash inflows associated with the proposal as shown below. The firm has a 12 percent cost of capital.

a.   Calculate the payback period for the proposed investment.

b.   Calculate the NPV for the proposed investment.

c.   Calculate the IRR for the proposed investment.

d.   Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project? Why?

I believe the answers are as follows:

a.         The payback period is 3.56 years

b.   NPV is $8,672.54

c.   IRR is 15.6% or 16%

d.   This project is acceptable by both NPV and IRR criteria. It has a positive NPV and its IRR is greater than its hurdle rate of 12%.

What is the formulas used to calculate these answers?

End of Year (t) Cash Inflows (CFt) 1 $18,000 2 $22,500 3 $27,000 4 $31,500 5 $36,000

Explanation / Answer

a.   Calculate the payback period for the proposed investment.

Payback period in capital budgeting refers to the period of time required to recoup the funds expended in an investment

Ans : Payback Period = (A - 1) + Cost - Cumulative Present Value of Cash Flow( A - 1)/Present Value of Cash FlowA

Where:

The cumulative cash flows from investment exceed the initial investment of $85000 in the year 4 (Year A).

therefore A-1 = 3

= 3 + 85000-67500/31500 = 3.56 years

b.   Calculate the NPV for the proposed investment.

NPV    =          PV of cash inflows - Initial investment

A = Year in which the cumulative present value of cash flows from investment exceed the initial cost. A - 1 = The year prior to A. Present Value of Cash FlowA = Present value of Net cash flow in Year A. Cumulative Present Value of Cash Flow( A - 1) = Cumulative Present Value of the Cash Flows from investment at the end of the Year (A - 1). Cost = The initial cost of investment.

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.