Using a 3.8% discount rate, calculate the NPV, Payback, Profitability, index, an

Question

Using a 3.8% discount rate, calculate the NPV, Payback, Profitability, index, and IRR for investment projects; Project 1 initial investment= $520,00, cash inflows of 100,000 for 1-5 years and 50,000 for 6-10 years.

Project 2 initial investment= $1,050,000, incash flow 400,000 for 1-3 years, $0 for 4-7 years, and $250,000 for years 8-10

Project 3 initial investment= $820,000, incash flows300,000 for years 1-5, $0 for 6-9, 100,000 for year 10

Project 4 initial investment= $820,000, cash inflows of 300,000 for years 1-5, $0 for years 4-7, and 100,000 for years 10

part 2 assuming a budget of $1,300,000 what are thw recomendations for the tree projects in the abouve problem?

assuming a budget of $2,100,000 what are your recomendations for above problem?

Explanation / Answer

The payback period is the time that it takes for the cumulative undiscounted cash inflows to

equal the initial investment.

Project A:

Cumulative cash flows Year 1 = $4,000 = $4,000

Cumulative cash flows Year 2 = $4,000 +3,500 = $7,500

Payback period = 2 years

Project B:

Cumulative cash flows Year 1 = $2,500 = $2,500

Cumulative cash flows Year 2 = $2,500 + 1,200 = $3,700

Cumulative cash flows Year 3 = $2,500 + 1,200 + 3,000 = $6,700

Companies can calculate a more precise value using fractional years. To calculate the fractional

payback period, find the fraction of year 3%u2019s cash flows that is needed for the company to have

cumulative undiscounted cash flows of $5,000. Divide the difference between the initial

investment and the cumulative undiscounted cash flows as of year 2 by the undiscounted cash

flow of year 3.

Payback period = 2 + ($5,000 %u2013 $3,700) / $3,000

Payback period = 2.43

Since project A has a shorter payback period than project B has, the company should choose

project A.

b. Discount each project%u2019s cash flows at 15 percent. Choose the project with the highest NPV.

Project A:

NPV = %u2013$7,500 + $4,000 / 1.15 + $3,500 / 1.152

+ $1,500 / 1.153

NPV = %u2013$388.96

Project B:

NPV = %u2013$5,000 + $2,500 / 1.15 + $1,200 / 1.152

+ $3,000 / 1.153

NPV = $53.83

The firm should choose Project B since it has a higher NPV than Project A has.

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