A project takes two year to complete and costs $10 MM in the first year and $20
ID: 2767049 • Letter: A
Question
A project takes two year to complete and costs $10 MM in the first year and $20 MM in the second year. After the completion of the project, it will have the following cash flows for the next 6 years Year (after completion of project) 1 2 3 4 5 6 Cash Flow 5 10 12 15 10 8 What is the IRR of this project? What is the maximum discount rate for which the project is economically viable? If the discount rate is 15%, should the project be undertaken? How long is the pay tack period of this project? Using discount rate of 15%, that is the discounted payback period of this project? Suppose the project will be undertaken if the discounted payback period does not exceed 4 years. What is the maximum discount rate that would make the project to be undertaken?Explanation / Answer
1
Calculation of IRR of the Project:
Year
Cash Flows
Before 1 Year
$(10,000,000)
Now
$(20,000,000)
Year 1
$ 5,000,000
Year 2
$ 10,000,000
Year 3
$ 12,000,000
Year 4
$ 15,000,000
Year 5
$ 10,000,000
Year 6
$ 8,000,000
IRR=
20%
(Using Excel formula "=IRR()"
2
Maximum Discount rate at which project is viable shall be IRR = 20%
3
Calculation of NPV of the project:
Year
Cash Flows
PVF (15%)
PV
CF
Calculation
PVF
CF *PVF
Before 1 Year
$(10,000,000)
(1+15%)^1
1.15000
$(11,500,000.00)
Now
$(20,000,000)
(1+15%)^0
1.00000
$(20,000,000.00)
Year 1
$ 5,000,000
1/(1+15%)^1
0.86957
$ 4,347,826.09
Year 2
$ 10,000,000
1/(1+15%)^2
0.75614
$ 7,561,436.67
Year 3
$ 12,000,000
1/(1+15%)^3
0.65752
$ 7,890,194.79
Year 4
$ 15,000,000
1/(1+15%)^4
0.57175
$ 8,576,298.68
Year 5
$ 10,000,000
1/(1+15%)^5
0.49718
$ 4,971,767.35
Year 6
$ 8,000,000
1/(1+15%)^6
0.43233
$ 3,458,620.77
NPV =
$ 5,306,144.35
The Project has positive NPV, hence it should ne undertaken.
4
Calculation of Payback Period for project:
Year
Cash Flows
Cumulative CF
CF
Before 1 Year
$(10,000,000)
$ (10,000,000)
Now
$(20,000,000)
$ (30,000,000)
Year 1
$ 5,000,000
$ (25,000,000)
Year 2
$ 10,000,000
$ (15,000,000)
Year 3
$ 12,000,000
$ (3,000,000)
Year 4
$ 15,000,000
$ 12,000,000
Year 5
$ 10,000,000
$ 22,000,000
Year 6
$ 8,000,000
$ 30,000,000
Cash Flows becomes positive in year 4, hence Payback Period =
=3 Years + (3000000/15000000)
= 3.2 Years
1
Calculation of IRR of the Project:
Year
Cash Flows
Before 1 Year
$(10,000,000)
Now
$(20,000,000)
Year 1
$ 5,000,000
Year 2
$ 10,000,000
Year 3
$ 12,000,000
Year 4
$ 15,000,000
Year 5
$ 10,000,000
Year 6
$ 8,000,000
IRR=
20%
(Using Excel formula "=IRR()"
2
Maximum Discount rate at which project is viable shall be IRR = 20%
3
Calculation of NPV of the project:
Year
Cash Flows
PVF (15%)
PV
CF
Calculation
PVF
CF *PVF
Before 1 Year
$(10,000,000)
(1+15%)^1
1.15000
$(11,500,000.00)
Now
$(20,000,000)
(1+15%)^0
1.00000
$(20,000,000.00)
Year 1
$ 5,000,000
1/(1+15%)^1
0.86957
$ 4,347,826.09
Year 2
$ 10,000,000
1/(1+15%)^2
0.75614
$ 7,561,436.67
Year 3
$ 12,000,000
1/(1+15%)^3
0.65752
$ 7,890,194.79
Year 4
$ 15,000,000
1/(1+15%)^4
0.57175
$ 8,576,298.68
Year 5
$ 10,000,000
1/(1+15%)^5
0.49718
$ 4,971,767.35
Year 6
$ 8,000,000
1/(1+15%)^6
0.43233
$ 3,458,620.77
NPV =
$ 5,306,144.35
The Project has positive NPV, hence it should ne undertaken.
4
Calculation of Payback Period for project:
Year
Cash Flows
Cumulative CF
CF
Before 1 Year
$(10,000,000)
$ (10,000,000)
Now
$(20,000,000)
$ (30,000,000)
Year 1
$ 5,000,000
$ (25,000,000)
Year 2
$ 10,000,000
$ (15,000,000)
Year 3
$ 12,000,000
$ (3,000,000)
Year 4
$ 15,000,000
$ 12,000,000
Year 5
$ 10,000,000
$ 22,000,000
Year 6
$ 8,000,000
$ 30,000,000
Cash Flows becomes positive in year 4, hence Payback Period =
=3 Years + (3000000/15000000)
= 3.2 Years
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