Question

Suppose you have the following projected cash flows for a drone pizza delivery business: an initial investment cost of $2,300,000, and with expected net revenues of $850,000 each year for six years. If the required return for the risk of this project is 12%, then

1. What is the NPV of this project?

2. What is the Profitability Index for this project?

3. What is the Internal Rate of Return for this project?

4. What is the Payback Period of this project? Suppose the cut off period is 2 years.

5. Should you accept this project?

If applicable, show the formulas used to find these answers.

Answer 1

a
Project
Discount rate	0.12
Year	0	1	2	3	4	5	6
Cash flow stream	-2300000	850000	850000	850000	850000	850000	850000
Discounting factor	1	1.12	1.2544	1.404928	1.5735194	1.762342	1.973823
Discounted cash flows project	-2300000	758928.6	677614.8	605013.2	540190.37	482312.8	430636.5
NPV = Sum of discounted cash flows
NPV Project =	1194696.22
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
c
Project
PI= (NPV+initial inv.)/initial inv.
=(1194696.22+2300000)/2300000
1.52
b
Project
IRR is the rate at which NPV =0
IRR	0.288992281
Year	0	1	2	3	4	5	6
Cash flow stream	-2300000	850000	850000	850000	850000	850000	850000
Discounting factor	1.00E+00	1.288992	1.661501	2.141662	2.7605859	3.558374	4.586717
Discounted cash flows project	-2300000	659429.9	511585.6	396888	307905.65	238873.2	185317.8
NPV = Sum of discounted cash flows
NPV Project =	0.00%
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	28.90%
d
Project
Year	Cash flow stream	Cumulative cash flow
0	-2300000	-2300000
1	850000	-1450000
2	85000000.00%	-600000
3	850000	250000
4	85000000.00%	1100000
5	850000	1950000
6	850000	2800000
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 2 and 3
therefore by interpolation payback period = 2 + (0-(-600000))/(250000-(-600000))
2.71 Years

E

Reject the project as payback period is more than cutoff of 2 years