? YEAR ? ? CASH FLOW( CF) ? ? ? 0 $ - 220,000 ? 1 30,000 ? ? ? 2 50,000 ? ? ? 3
ID: 2634011 • Letter: #
Question
? YEAR ? ?CASH FLOW(CF) ?
? ?0
$ - 220,000 ?
1
30,000 ?
? ?2
50,000 ?
? ?3
60,000 ?
? ?4
60,000 ?
5
60,000 ?
? ?6
60,000 ?
? ?
? ? ? ? ??
(6 Points) What is the payback period?
(10 Points) What is the NPV?
(5 Points) Dr. Payne states that since, according to the payback period he should get all his investment back, then he should proceed with the new office. What would you tell him?
? ?0
$ - 220,000 ?
1
30,000 ?
? ?2
50,000 ?
? ?3
60,000 ?
? ?4
60,000 ?
5
60,000 ?
? ?6
60,000 ?
? ?
? ? ? ? ??
Explanation / Answer
Hi,
Please find the detailed answer as follows:
Part A:
The initial investment of $220000 will get recovered as follows:
Year 1 = 30000
Year 2 = 50000
Year 3 = 60000
Year 4 = 60000
and the balance of 20000 (220000 - 30000 - 50000 - 60000 - 60000) between Year 4 and Year 5
Payback Period = 4 + 20000/60000 = 4.33 Years
Answer for Part A is 4.33 Years.
----
Part B:
NPV = -220000 + 30000/(1+.12)^1 + 50000/(1+.12)^2 + 60000/(1+.12)^3 + 60000/(1+.12)^4 + 60000/(1+.12)^5 + 60000/(1+.12)^6 = -8073.21
----
Part C:
No, the investment should not be made, since NPV is negative even if the investment if recovered as per the payback method. It is so because NPV method doesn't take time value of money into consideration and hence cannot be considered as the appropriate tool for making an investment decision.
Thanks.
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