1) HNE Enterprises is considering the following project with the following annua
ID: 2730081 • Letter: 1
Question
1) HNE Enterprises is considering the following project with the following annual cash flows.
Year 0 1 2 3 4
Cash Flow -$10 $9 $2 $3 -$5
a) What is the payback period for this project?
b) What is the discounted payback period for this project if the discount rate is 20%?
c) If HNE Enterprises has a cutoff period of 2 years, briefly explain if they would accept this project under the payback method? What about the discounted payback method?
d) What is the net present value of this project if the discount rate is still 20%? Briefly explain if they should accept this project based on NPV analysis.
e) Suppose there are 10 shares outstanding of HNE Enterprises selling for $10 per share. If they undertake this project, what would you calculate their share price should be assuming Small Inc. is a common-equity only company?
Explanation / Answer
a) In the Year 4, a cash outflow of $5 is expected which could be due to further capital investment or trading losses. The result of the cash outflow in year 4 is that the cumulative cash inflows again drop below the cost of investment. To solve this anomaly, we may calculate a Modified payback period
Initial investment as per Modified payback period = 10+5 = $15
The proposed project cannot payback the investment Or if any residue can be realised the payback period will exceed 4years
b) Initial investment as per Modified discounted payback period = 10 + 5(1/1.20)4 = $12.41
The proposed project cannot payback the investment Or if any residue can be realised the payback period will exceed 4years
c) If HNE Ltd has a cutoff period of 2years, the project cannot be accept under neither in Payback period method or Discounted payback period method.
d)
Project should not be accepted as the NPV is negative.
e) If the project is accepted, then the Share value will be reduced by $ 0.1785 per share (-1.785/10)
Revised share price after accepting the project = $ 9.8215 per share
Year Cashflow ($) Cummulative CF ($) 1 9 -6 2 2 -4 3 3 -1 4 0 -1Related Questions
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