1. Your company (Apple Inc) is considering using the payback period for capital-
ID: 2649818 • Letter: 1
Question
1. Your company (Apple Inc) is considering using the payback period for capital-budgeting. Discuss the advantages and disadvantages of this technique.
2. Your company (Apple Inc) is considering the construction of a new building. The building will have an initial cash outlay of $7 million, and will produce cash flows of $3 million at the end of year 1, $4 million at the end of year 2, and $2 million at the end of years 3 through 5.
What is the internal rate of return on this new building? Would you recommend the company proceed with the construction? Why or why not?
3. Your company ( Apple Inc) is considering two mutually-exclusive projects. Both require an initial outlay of $10,000 and will operate for 5 years.
Project A will produce expected cash flows of $5,000 per year for years 1 through 5, whereas project B will produce expected cash flows of $6,000 per year for years 1 through 5. Because project B is the riskier of the two projects, management has decided to apply a required rate of return of 15 percent to its evaluation but only a 12 percent required rate of return to project A.
Discuss each project
Explanation / Answer
1) Payback period is said to be the period in which the amount invested by the company in the project is realised . This method is advantageous as we can get to know how much time the project will take to return the initial inveted amount but this method is not at all gooid for decision making becuase we do not satrt the project to just get back the amount invested in the project instaed we satrt the project to earn some profit extra then the amount invested and for this criteria NPV is considered as the best decision making method
2) Calculation of NPV
-176400
IRR= 10% + 12.81 i.e 22.81 %
Project should be accepted becuase the payback period is good just 2 years and IRR is very high that means below the IRR rate NPV will be positive
3) NPV of project A = 5000*PVAF(12%,5Years)-10000
= 5000*3.6048-10000
= 8024
NPV of project B = 6000* PVAF ( 15% , 5Years) -10000
= 6000*3.3522-10000
= 20113-10000
= 10113
Particulars Year Cash flows PVF @ 10% PV @ 10% PVF @ 30% PV @ 30% Cash outflow 0 7000000 1 7000000 1 7000000 Present value of cash outflows 7000000 7000000 Cash inflow Year 1 1 3000000 0.909 2727000 0.7692 2307600 Cash inflow Year 2 2 4000000 0.8264 3305600 0.5917 2366800 Cash inflow Year 3 3 2000000 0.7513 1502600 0.4552 910400 Cash inflow Year 4 4 2000000 0.683 1366000 0.3501 700200 Cash inflow Year 5 5 2000000 0.6209 1241800 0.2693 538600 Present value of cash inflows 10143000 6823600 Net present value 3143000
-176400
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