19-1: A) A project requires an initial cash outlay of $800, and returns $1,000 a

Question

19-1:

A)        A project requires an initial cash outlay of $800, and returns $1,000 at the end of year 3 (nothing at the end of years 1 or 2). What is the approximately Net Present Value of this project, using a cost of capital of 10%?

             

B)        A project requires an initial cash outlay of $5,000, and returns $1,000 at the end of each year from Year 1 through Year 10. What is the project’s approximate Internal Rate of Return.

           

C)        Refer to the project in part (B). What is the Payback Period of the Project? Also, what is the Accounting Rate of Return on the average net investment, assuming that the $5,000 purchase price is for a machine that is depreciated using straight-line depreciation over 10 years, with zero salvage value?

Explanation / Answer

Question A

Net present value=Prevent value discounted cash inflows-Cashoutflows

=$1000*PVIF(10%,3years)-$800

=$1000*0.7513-$800

=$751.3-$800

=-$48.7

Since NPV of the project is negative the project should not be accepted

Question B

Calculation of Internal Rate of Return

IRR is the rate at which the NPV of the project will be zero

and assuming IRR is 16%

Hence IRR may be in between 15 and 16%

Hence IRR may be considered as 15%

Question C

Payback period of the project is Cash outflow/CAsh inflow p.a

=$5000/$1000

=5 years

Depreciation=(Cost of asset-Salvage value)/Life value

=$5000/10

=$500

Average Investmetn=$5000-$500=$4500

ARR=Average net income/average investment

=$1000/$4500

=0.22

=22%

Assuming IRR is 15% Year Project Cash Flows Discounting factor@15% Discounted Cash Flows 0 -5000 1 -5000 1 1000 0.8696 869.6 2 1000 0.7561 756.1 3 1000 0.6575 657.5 4 1000 0.5718 571.8 5 1000 0.4972 497.2 6 1000 0.4323 432.3 7 1000 0.3759 375.9 8 1000 0.3269 326.9 9 1000 0.2843 284.3 10 1000 0.2472 247.2 NPV 18.8

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