Describe the use of internal rate of return (IRR), net present value (NPV), and

Question

Describe the use of internal rate of return (IRR), net present value (NPV), and the payback method in evaluating project cash flows.

Describe the advantages and disadvantages of each method.

Calculate the following time value of money problems:

If you want to accumulate $500,000 in 20 years, how much do you need to deposit today that pays an interest rate of 15%?

What is the future value if you plan to invest $200,000 for 5 years and the interest rate is 5%?

What is the interest rate for an initial investment of $100,000 to grow to $300,000 in 10 years?

If your company purchases an annuity that will pay $50,000/year for 10 years at a 11% discount rate, what is the value of the annuity on the purchase date if the first annuity payment is made on the date of purchase?

What is the rate of return required to accumulate $400,000 if you invest $10,000 per year for 20 years. Assume all payments are made at the end of the period.

Calculate the project cash flow generated for Project A and Project B using the NPV method.

Which project would you select, and why?

Which project would you select under the payback method? The discount rate is 10% for both projects.

Use Microsoft® Excel® to prepare your answer.

Note that a similar problem is in the textbook in Section 5.1.

Sample Template for Project A and Project B:

Project A:

Initial investment: $10,000

year 1: $5,000

year 2: $5,000

Year 3: $5,000

Project B:

Initial investment: $55,000

y1: $20,000

y2: $20,000

y3: $20,000

Explanation / Answer

Question 1)

If you want to accumulate $500,000 in 20 years, how much do you need to deposit today that pays an interest rate of 15%?

Ans:

Deposit today FV×(1÷(1+r)^n) Here, 1 rate per annum 15.00% 2 Number of years                                            20 3 Number of compoundings per per annum                                              1 4 = 1÷3 rate per period ( r) 15.00% 5 = 2×3 Number of periods (n)                                            20 Future value (FV) $                             500,000 Deposit today $                         30,550.14 500000*(1/(1+15%)^20)

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