Question

1. Chronic Pain Clinic has estimated the following cash flows associated with a new project. The project cost of capital (discount rate) is 8 percent.

Year 0: ($700,000)

Year 1: $400,000

Year 2: $400,000

Year 3: $400,000

2. What is the project’s net present value?

A. $186,897

B. $197,619

C. $208,225

D. $324,538

E. $330,839

Chronic Pain Clinic has estimated the following cash flows associated with a new project. The project cost of capital (discount rate) is 9 percent.

Year 0: ($850,000)
Year 1: $400,000
Year 2: $400,000
Year 3: $400,000

What is the project’s internal rate of return?

A. 18.5 percent

B. 19.4 percent

C. 20.6 percent

D. 23.8 percent

E. 24.4 percent

3. Assume a project has the following expected cash flows:

Year 0: ($350,000)
Year 1: $125,000
Year 2: $130,000
Year 3: $170,000
Year 3: $200,000

What is the project’s payback (payback period)?

A. 2.20 years

B. 2.45 years

C. 2.54 years

D. 2.62 years

E. 3.05 years

Answer 1

2. Answer is E

In order to calculate NPV, we need to calculate the sum of all cashlfows discounted at time, t = 0, by 8%

CF₀ = -700,000, CF₁ = 400,000, CF₂ = 400,000, CF₃ = 400,000

NPV = -700000 + 370370.4 + 342935.5 + 317532.9 = 330838.79

Project's IRR = 19.4%

In order to calculate this, you need to calculate 'r' in the NPV formula (mentioned above), such that NPV = 0. Manual calculations for IRR are lengthy and should be avoided. Use Excel or Financial calculator to calculate the same.

In Excel, you can use IRR function with cashflows (having appropriate signs - positive for inflow and negative for outflow) as arguments.

3. Answer is C

For calculating the payback, you need to calculate the number of years it would take you to earn back your invested amount.

So, adding cashflows in year 1 and year 2 = $255,000. They would need $95000 more to complete their re-earning of invested amount. But, in year 3, cashflow occuring is $170,000 which is more than that we require.

So, by extrapolation, if company earns $170,000 in that year, it would earn 95,000 in = 95000/170000 = 0.56 years

This implies, total payback = 2 Years + 0.56 year = 2.56 years This is closest to 2.54 years in options)