Question

Cash Payback Period, Net Present Value Method, and Analysis

Elite Apparel Inc. is considering two investment projects. The estimated net cash flows from each project are as follows:

Year	Plant Expansion		Retail Store Expansion
1	$101,000		$85,000
2	83,000		99,000
3	71,000		68,000
4	65,000		48,000
5	20,000		40,000
Total	$340,000		$340,000

Each project requires an investment of $184,000. A rate of 12% has been selected for the net present value analysis.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1a. Compute the cash payback period for each project.

	Cash Payback Period
Plant Expansion	2 years
Retail Store Expansion	2 years

1b. Compute the net present value. Use the present value of $1 table above. If required, round to the nearest dollar.

	Plant Expansion	Retail Store Expansion
Present value of net cash flow total	$	$
Less amount to be invested	$	$
Net present value	$	$

2. Because of the timing of the receipt of the net cash flows, the plant expansion offers a higher net present value .

Feedback

1a. For each project, start with year 1 and accumulate the net cash flows until the amount to be invested is reached.

1b. For each project, multiply the present value factor for each year (Exhibit 2) by that year's net cash flow. Subtract the amount to be invested from the total present value of the net cash flow. Which project offers the more favorable net present value?

2. Consider when cash flows are received and the time value of money.

Learning Objective 2, Learning Objective 3.

Check My Work

Answer 1

Solution:
1.a.	Cash payback period for each project is the period during which its initial investment is recovered.
			Plant Expansion	Retail Store Expansion
	Initial Investment		$ 184,000	$ 184,000
	Year 1 Net Cash flows		$ 101,000	$ 99,000
	Year 2 Net Cash flows		$ 83,000	$ 68,000
	Since we can observe that investment of $ 184,000 is recovered in 2 years in both cases of expansion
	Hence
			Cash Payback period
	Plant Expansion		2 Years
	Retail Store Expansion		2 Years
1.b.	Computation of NPV of Expansions
			Plant Expansion	Retail Store Expansion
	PV of net cash flow total		259576	2,56,432
Less:	Amount to be invested		1,84,000	1,84,000
	Net Present Value		75,576	72,432
Working Notes:
Plant Expansion
	Year	Cash Flow	PVF @ 12%	Present value
	1	1,01,000	0.893	90193
	2	83,000	0.797	66151
	3	71,000	0.712	50552
	4	65,000	0.636	41340
	5	20,000	0.567	11340
		Present value of net cash flow Total		259576
Retail Store Expansion
	Year	Cash Flow	PVF @ 12%	Present value
	1	85,000	0.893	75905
	2	99,000	0.797	78903
	3	68,000	0.712	48416
	4	48,000	0.636	30528
	5	40,000	0.567	22680
		Present value of net cash flow Total		2,56,432
2	Because of the timing of the receipt of the net cash flows, the Plant expansion offers a higher net present value
	As the Payback period is same in the both the cases and The Net Present Value is Positive Plant Expansion an amount of $3144 So choose Plant Expansion.