An investment project has annual cash inflows of S4.200. 55.300. S6.100. and S7.

Question

An investment project has annual cash inflows of S4.200. 55.300. S6.100. and S7.400. and a discount rate of 14 percent. What is the discounted payback period for these cash flows if the initial cost is S7,000? You're trying to determine whether to expand your business by building a new manufacturing plant. The plant has an installation cost of $15 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1.938.200. $2.20l.600. $1.876.000. and $1.329.500 over these four years, what is the project's average accounting return (AAR)? For the given cash flows, suppose the firm uses the NPV decision rule. At a required return of 11 percent, should the firm accept this project? What if the required return was 30 percent? What is the profitability index for the following set of cash flows if the relevant discount rate is 10 percent?

Explanation / Answer

13) Discounted payback period = 1.81 years.

calculations:

Discounted pay back = 1 + (7000-3684)/4078 = 1.81 years

14) Average net income = (1938200+2201600+1876000+1329500)/4 = $1,836,325

Average investment = (15000000 + 0)/2 = 7,500,000

Average accounting return = 1836325/7500000 = 24.48%.

15) If the required return is 11%, the project can be accepted as the NPV is positive @ $5,991.

calculations:

If the required return is 30%, the project should not be accepted as the NPV is negative at -$4214

calculations:

16) The profitability index = 1.19

calculations:

cumulative year cash flows pvif @ 14% pv pv 1 4200 0.8772 3684 3684 2 5300 0.7695 4078 7762 3 6100 0.6750 4117 11880 4 7400 0.5921 4381 16261 16261 Initial cost $7000

Discounted pay back = 1 + (7000-3684)/4078 = 1.81 years

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