1. Suppose Palmer Properties is considering investing $2.6 million today (i.e.,
ID: 2714665 • 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
(a) What is the payback period for the project? Show your work
Payback period = 5 + 450000/800000
Payback period = 5.5625 Years
(b) What is the net present value of the project ? Show your work
Net present value = Cash Flow Year0/(1+r)^0+Cash Flow Year1/(1+r)^1+Cash Flow Year2/(1+r)^2+Cash Flow Year3/(1+r)^3+Cash Flow Year4/(1+r)^4+Cash Flow Year5/(1+r)^5+Cash Flow Year6/(1+r)^6+Cash Flow Year7/(1+r)^7
Net present value = -2600000/(1+8%)^0-250000/(1+8%)^1 +300000/(1+8%)^2 +500000/(1+8%)^3 + 800000/(1+8%)^4+800000/(1+8%)^5+800000/(1+8%)^6+800000/(1+8%)^7
Net present value = -73,945.26
(c) What is the internal rate of return on the project ? Show your work
Using Equition & trial run error method
At IRR, PV of cash outflow = PV of cash Inflow
therefore
2600000/(1+r)^0 + 250000/(1+r)^1 = 300000/(1+r)^2+500000/(1+r)^3+800000/(1+r)^4+800000/(1+r)^5 + 800000/(1+r)^6+800000/(1+r)^7
By solving above equation
We get
r = 7.39%
Using Excel Formula
Internal rate of return on the project = irr(values)
Internal rate of return on the project = irr({-2600000,-250000,300000,500000,800000,800000,800000,800000})
Internal rate of return on the project = 7.39%
(d) Under which method(s) above should the company accept the project (applying the acceptance rules)? Explain
None of the method(s) above would accet the project.
The company should not accept the project due to :
Year Cash Flow Cummulative Cash Flow C0 -2600000 -2600000 C1 -250000 -2850000 C2 300000 -2550000 C3 500000 -2050000 C4 800000 -1250000 C5 800000 -450000 C6 800000 350000 C7 800000 1150000Related Questions
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