You work for a small, local telecommunications company. In five years, the compa
ID: 2730925 • Letter: Y
Question
You work for a small, local telecommunications company. In five years, the company plans to undertake a major upgrade to its servers and other IT infrastructure. Management estimates that it will need up to $450,000 to cover all related costs; however, as a fairly young company, the goal is to pay for the upgrade with cash and not to take out loans. Right now, you have $300,000 in a bank account established for Capital Investments. This account pays 6% interest, compounded annually. A member of the finance department has approached you with an investment opportunity for the $300,000 that covers a five-year period and has the following projected after-tax cash flows: Year Projected Cash Flow 1 $94,000 2 $114,000 3 $134,000 4 $114,000 5 $94,000 Based on this information, answer the following questions: 1) How much money will be in the bank account if you leave the $300,000 alone until you need it in five years? 2) If you undertake the investment opportunity, what is the Nominal Payback Period? 3) Using the factors for 6%, what is the Discounted Payback Period? 4) What is the Net Present Value of this investment opportunity? 5) Which option – make the investment or leave the money in a savings account – would you recommend to your CEO? Why? What additional factors/information might make you change your point of view?Explanation / Answer
1. Amount of money in the bank account if the company leaves the $ 300,000 alone in the bank account =
Year 1 = $300,000 + 6% of 300,000
= $ 318,000
Year 2 = $ 318,000 + 6% of $318,000
= $ 337,080
Year 3 = $ 337,080 + 6% of $ 337,080
= $ 357,305
Year 4 = $ 357,305 + 6% of $ 357,305
= $ 378,743
Year 5 = $ 378,743 + 6 % of $ 378,743
= $ 401,468
2. Nominal Pay Back Period =
Year Cash Flow $ Cummulative Cash Flow $
0 - 300,000 -300,000
1 94,000 -206,000
2 114,000 - 92,000
3 134,000 42,000
4 114,000 156,000
5 94,000 250,000
Pay Back period= 2+92000/42000
= 4.19 years
3. Discounted Payback period =
Year Cash Flow $ Discounted Cash Flow $ Cummulative Cash Flow $
0 - 300,000 -300,000 -300,000
1 94,000 88,642 -211,358
2 114,000 101,460 - 109,898
3 134,000 112,560 2662
4 114,000 90,060 92,722
5 94,000 70,500 163,222
Pay Back period= 2+109898/112,560
= 2.98 years
4. Net Present Value =
Year Cash Flow $ Discounted Cash Flow $
0 - 300,000 -300,000
1 94,000 88,642
2 114,000 101,460
3 134,000 112,560
4 114,000 90,060
5 94,000 70,500
Net Present Value = 163,222
5. If the amount is left in the bank, we have $ 401,468 in hand at the end of 5th year for the Present Value of $300,000
If the Investment is made, Net Present Value is $ 163,22
Since, the Net Present Value is positive hence it is advisable to Invest.
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