Question

1) A project costs $150,000 and generates a cash flow of $75000 in year 1,$25000 in year 2 and then $10000 in year 3 through 10. What is the payback of the project?

a) 5 years

b) 6 years

c) 8 years

d) 7 years

2) A project requires an initial outflow of $100,000 and is expected to produce $20000 inflows over each of the next ten years. If the required return of the project is 8%, what is its profitablility index?

a) 2.88

b) 5

c) 10

d) 1.34

Answer 1

a.

Year	Cash flows	Cumulative Cash flows
0	(150,000)	(150,000)
1	75000	(75000)
2	25000	(50,000)
3	10,000	(40,000)
4	10,000	(30,000)
5	10,000	(20,000)
6	10,000	(10,000)
7	10,000	0
8	10,000	10,000
9	10,000	20,000
10	10,000	30,000

Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=7 years

2.Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=20,000/1.08+20,000/1.08^2+20,000/1.08^3+20,000/1.08^4+20,000/1.08^5+20,000/1.08^6+20,000/1.08^7+20,000/1.08^8+20,000/1.08^9+20,000/1.08^10

=134201.628

PI=Present value of inflows/Present value of outflows  

=134201.628/100,000

=1.34(Approx)