Question

A project that costs $2,800 to install will provide annual cash flows of $630 for the next 6 years. The firm accepts projects with payback periods of less than 4 years.

a-1.	What is this project's payback period? (Round your answer to 3 decimal places.)

Payback period

years

a-2.	Will the project be accepted?
	No Yes

b-1.	What is project NPV if the discount rate is 2%? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV

$

b-2.	Should this project be pursued?
	Yes No

b-3.	What is project NPV if the discount rate is 12%? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV

$

b-4.	Should this project be pursued?
	Yes No

b-5.	Will the firm’s decision change as the discount rate changes?

Answer 1

Answer a-1.

Payback Period = Initial Investment / Annual Cash Flows
Payback Period = $2,800 / $630
Payback Period = 4.444 years

Answer a-2.

The firm accepts projects with payback periods of less than 4 years. So, the firm should not accept this project.

Answer b-1.

Discount Rate = 2%

NPV = -$2,800 + $630/1.02 + $630/1.02^2 + $630/1.02^3 + $630/1.02^4 + $630/1.02^5 + $630/1.02^6
NPV = -$2,800 + $630 * (1 - (1/1.02)^6) / 0.02
NPV = -$2,800 + $630 * 5.601431
NPV = $728.90

Answer b-2.

The NPV of the project is positive. So, the firm should accept this project.

Answer b-3.

Discount Rate = 12%

NPV = -$2,800 + $630/1.12 + $630/1.12^2 + $630/1.12^3 + $630/1.12^4 + $630/1.12^5 + $630/1.12^6
NPV = -$2,800 + $630 * (1 - (1/1.12)^6) / 0.12
NPV = -$2,800 + $630 * 4.111407
NPV = -$209.81

Answer b-4.

The NPV of the project is negative. So, the firm should not accept this project.

Answer b-5.

Yes, the firm’s decision will change as the discount rate changes.