Question

The company's required rate of return or weighted average cost of capital is 8%. After computing payback period, NPV, PI, and IRR, state whether you would accept or reject each project. Management's arbitrarily set payback period is 2.75 years. Project homer details; Inital Outlay = $123000 ; cash inflows= $30,000 per years for 5 years. Compute NPV for Project Homer.

A) (23,640)

B) (3,210)

C) 33,180

D) 34,200

Answer 1

Year	Cash flows
0	$         (123,000)
1	$              30,000
2	$              30,000
3	$              30,000
4	$              30,000
5	$              30,000
NPV =	$              (3,219)
IRR =	7.00%
PI =	0.97
Payback =	4.10

Correct option of NPV is B) (3210). $9 difference is because of rounding off error.

From the above table, we can see that,

NPV is negative,

IRR is less than the required rate of return,

PI is below one, and

The payback period is 4.10 years which is greater than the management's arbitrarily set payback period of 2.75 years.

So this project must be rejected.

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