1. Suppose Palmer Properties is considering investing $2.6 million today (i.e.,
ID: 2714125 • Letter: 1
Question
1. Suppose Palmer Properties is considering investing $2.6 million today (i.e., C0 = -2,600,000) on a new project that is expected to last for 7 years. The project is expected to generate annual cash flows of C1 = -250,000; C2 = 300,000, C3 = 500,000 and then $800,000 for period C4 through C7. If the discount rate is 8% and management’s payback period cutoff is 5 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
Payback Period is the time taken for the project to return the investment
Project Outflow = 2600000
Project Inflow till 5 years = 2150000
Project Inflow till 6 years = 2950000
Project payback is between 5 and 6 years
Project payback = 5 + (2600000 – 2150000)/800000 = 5 years 205 days
TIME
Cash Flow
Present Value
0
-2600000
-2600000
1
-250000
-231481.48
2
300000
257201.65
3
500000
396916.12
4
800000
588023.88
5
800000
544466.56
6
800000
504135.70
7
800000
466792.32
NPV
-73945.26
IRR
7.4%
The company should not accept the project in any of the methods listed above due to following reasons:
Project payback is greater than the required cutoff
Project has a negative effect on wealth creation
Project has IRR less than the cost of capital
TIME
Cash Flow
Present Value
0
-2600000
-2600000
1
-250000
-231481.48
2
300000
257201.65
3
500000
396916.12
4
800000
588023.88
5
800000
544466.56
6
800000
504135.70
7
800000
466792.32
NPV
-73945.26
IRR
7.4%
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