Question

6. (Each part is worth 2 pts.) A new project that is being considered requires an initial investment of $375,000. The expected future cash flows are $250,000 per year for four years. Assume the appropriate discount rate is 15%. a. What is the NPV?   b. Suppose that the firm that’s considering this project has a market value of $2.2 million. If the firm accepts this project, what will be the firm’s new market value?   c. What is the IRR?   d. What is the discounted payback period? Include partial periods (e.g., x.xx years) in your response.

Answer 1

6. a . The initial investment is ($375,000)

CF0 = ($375,000)

CF1= $2,50,000

CF1 TO CF4 = $2,50,000

($375,000) + $250,000/1.15 + $250,000/1.15^2 + $250,000/1.15^3 + $250,000/1.15^4

= $338,744.5907

At discount rate of 15%, the NPV of the project is : $338,744.5907

Yes, as the NPV of the project is positive, this project should be accepted.

b. The market value of the firm, after a accepting this project is = $2,20,0000 + $338,744.5907

= $2538,744.591

As, the NPV of the project is positive, accepting this project will lead to an increase in the market value of the firm.

c. ($4,50,000) + 2,50,000/ (1 +IRR) + $2,50,000/ (1+IRR)^2 + 250,000/(1+IRR)^3 + 250,000/(1+IR)^4 = 0

So, the IRR of the project is :

The IRR of the project is 55.166

The discounted payback period is :

Year cash flows discounted cash flows

1 $250,000 $217,391.3043

2   $250,000   $189,035.9168

3 $250,000 $164,379.0581

4 $250,000 $142,938.3114

So, the discounted pay back period is :

= 2 + $43,572/ $164,379.0581

= 2.2603 years

SO, the discounted payback period is 2.2603 years.