2. Suppose Palmer Properties is considering investing $4.6 million today (i.e.,

Question

2. Suppose Palmer Properties is considering investing $4.6 million today (i.e., C0 = -4,600,000) on a new project that is expected to last for 8 years. The project is expected to generate annual cash flows of C1 = -200,000; C2 = 600,000, C3 = 750,000 and then $1,000,000 for period C4 through C8. If the discount rate is 7% and management’s payback period cutoff is 6 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 6.45 Years (b) Net Present Value $            -3,03,647 © Internal rate of return 5.64% (d) Net Present Value The Objective of Investment decision is wealth maximization.So, Net Present Value is the best basis for project selection. Workings: 1) Year Cash flow Cumulative Cash flow Discount factor Present Vaalue a b c d=1.07^-a b*d 0 $ -46,00,000 $                        -46,00,000                        1.000 $          -46,00,000 1 $   -2,00,000 $                        -48,00,000                        0.935 $            -1,86,916 2 $     6,00,000 $                        -42,00,000                        0.873 $              5,24,063 3 $     7,50,000 $                        -34,50,000                        0.816 $              6,12,223 4 $   10,00,000 $                        -24,50,000                        0.763 $              7,62,895 5 $   10,00,000 $                        -14,50,000                        0.713 $              7,12,986 6 $   10,00,000 $                          -4,50,000                        0.666 $              6,66,342 7 $   10,00,000 $                            5,50,000                        0.623 $              6,22,750 8 $   10,00,000 $                         15,50,000                        0.582 $              5,82,009 Net Present Value $            -3,03,647 2) Payback Period = 6+(450000/1000000) = 6.45 Years 3) Year Cash flow Discount factor Present Vaalue a b d=1.05^-a b*d 0 $ -46,00,000                                      1.000 $         -46,00,000 1 $   -2,00,000                                      0.952 $            -1,90,476 2 $     6,00,000                                      0.907 $             5,44,218 3 $     7,50,000                                      0.864 $             6,47,878 4 $   10,00,000                                      0.823 $             8,22,702 5 $   10,00,000                                      0.784 $             7,83,526 6 $   10,00,000                                      0.746 $             7,46,215 7 $   10,00,000                                      0.711 $             7,10,681 8 $   10,00,000                                      0.677 $             6,76,839 Net Present Value $             1,41,584 NPV At 5% $     1,41,584 At 7% $   -3,03,647 IRR = 5%+(7%-5%)*(141584/(141584+303647)) = 5.64%

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