The Bolster Company is considering the following project (Please note is is only
ID: 2739308 • Letter: T
Question
The Bolster Company is considering the following project (Please note is is only 1 project):
Year
Initial Outlay
NPV
0
-$100,000
-$100,000
1
$31,250
0
2
$31,250
0
3
$31,250
0
4
$31,250
0
5
$31,250
200,000
The required rate of return on this project is 12 percent.
a. What is the project’s payback period?
b. What is the project’s discounted payback period?
c. What is the project’s net present value?
d. Calculate the Profitability Index (PI) on this project.
e. What financial principles are important to solving this problem?
Year
Initial Outlay
NPV
0
-$100,000
-$100,000
1
$31,250
0
2
$31,250
0
3
$31,250
0
4
$31,250
0
5
$31,250
200,000
Explanation / Answer
Step-1:
Calculation of payback period:
Years
Cash flows
Accumulated cash flows
0
$ -1,00,000.00
$ -1,00,000.00
1
$ 31,250.00
$ 31,250.00
2
$ 31,250.00
$ 62,500.00
3
$ 31,250.00
$ 93,750.00
4
$ 31,250.00
$ 1,25,000.00
5
$ 31,250.00
$ 1,56,250.00
= Years +Initial investment / Cash inflows
= 4 + $100,000 / $121,875
= 4 + 0.82
= 4.82 years
Step-2:
Project discounted payback period:
Years
cash flow
discount factor 12%
Discount cash flow
cumulative discount flow
0
$ -1,00,000.00
1
$ -1,00,000.00
$ -1,00,000.00
1
$ 31,250.00
0.9881
$ 30,878.00
$ 69,122.00
2
$ 31,250.00
0.9764
$ 30,513.00
$ 38,609.00
3
$ 31,250.00
0.9648
$ 30,150.00
$ 8,459.00
4
$ 31,250.00
0.9534
$ 29,793.00
$ -21,334.00
5
$ 31,250.00
0.9421
$ 29,441.00
Step-3:
Calculate net present value:
Years
cash flow
discount factor 12%
present value
1
$ 31,250.00
0.9881
$ 30,878.00
2
$ 31,250.00
0.9764
$ 30,513.00
3
$ 31,250.00
0.9648
$ 30,150.00
4
$ 31,250.00
0.9534
$ 29,793.00
5
$ 31,250.00
0.9421
$ 29,441.00
Total
$ 1,50,775.00
Initial Investment
$ 1,00,000.00
NPV
$ 50,775.00
Step-4:
Calculate Profitability index:
= Future cash flows / Initial investment
= $150,775 / $100,000
= 1.50
Years
Cash flows
Accumulated cash flows
0
$ -1,00,000.00
$ -1,00,000.00
1
$ 31,250.00
$ 31,250.00
2
$ 31,250.00
$ 62,500.00
3
$ 31,250.00
$ 93,750.00
4
$ 31,250.00
$ 1,25,000.00
5
$ 31,250.00
$ 1,56,250.00
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