Question

A).

You are evaluating a project with the following cash flows: initial investment is $-12, and the expected cash flows for years 1 - 3 are $10, $11 and $17 (all cash flows are in millions of dollars). What is this projects NPV? The company's WACC is 10%.

B).

You are evaluating a project with an initial investment of $16.9 million dollars, and expected cash flows of $7 million dollars each for years 1-3. What is the project's simple payback? The corporate WACC is 10%

Answer 1

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)ⁿ

So, the NPV is computed as follows:

= - $ 12 million + $ 10 million / 1.10 + $ 11 million / 1.10² + $ 17 million / 1.10³

= $ 18.95 million Approximately

Payback period represents the time period in which the initial investment in a project is recovered.

Payback period is computed as follows:

The cumulative cash inflow of year 1 and 2 is computed as follows:

= $ 7 million + $ 7 million

= $ 14 million

The cumulative cash inflow of year 1, 2 and 3 is computed as follows:

= $ 7 million + $ 7 million + $ 7 million

= $ 21 million

It means that the initial investment of $ 16.9 million is recovered between year 2 and year 3 and hence the payback period lies between year 2 and year 3 and is computed as follows:

= 2 years + Remaining investment to be recovered / Year 3 cash inflow

= 2 years + ( $ 16.9 million - $ 14 million) / $ 7 million

= 2.41 years Approximately

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