P9 20 Payback, NPV, and IRR Rieger International is attempting to evaluate the f
ID: 2673282 • Letter: P
Question
P9 20 Payback, NPV, and IRRRieger International is attempting to evaluate the feasibility of investing $ 95,000 in a piece of equipment that has a 5- year life. The firm has estimated the cash inflows associated with the proposal as shown in the table at the right. The firm has a 12% cost of capital.
Year ( t) Cash inflows ( CFt)
1 $ 20,000
2 25,000
3 30,000
4 35,000
5 40,000
a. Calculate the payback period for the proposed investment.
b. Calculate the net present value ( NPV) for the proposed investment.
c. Calculate the internal rate of return ( IRR), rounded to the nearest whole percent, 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?
Explanation / Answer
a. Calculate the payback period for the proposed investment. Payback period 3 + ($20,000 /$35,000) = 3.57 years b. Calculate the net present value (NPV) for the proposed investment. PV of cash inflows Year CF PVIF12%,n PV 1 $20,000 .893 $ 17,860 2 25,000 .797 19,925 3 30,000 .712 21,360 4 35,000 .636 22,260 5 40,000 .567 22,680 $104,085 NPV = PV of cash inflows - Initial investment NPV = $104,085 - $95,000 NPV = $9,085 c. Calculate the internal rate of return (IRR), rounded to the nearest whole percent, for the proposed investment. IRR = 15% (15.36%) d. Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project? Why? NPV = $9,085; since NPV > 0; accept IRR = 15%; since IRR > 12% cost of capital; accept The project should be implemented since it meets the decision criteria for both NPV and IRR.
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