Question

You are evaluating a project that will cost

$497,000​,

but is expected to produce cash flows of

$123,000

per year for

10

​years, with the first cash flow in one year. Your cost of capital is

11.2%

and your​ company's preferred payback period is three years or less.

a. What is the payback period of this​ project?

b. Should you take the project if you want to increase the value of the​ company?

a. What is the payback period of this​ project?

The payback period is

nothing

years.  ​(Round to two decimal​ places.)

Answer 1

a.Cash flow in year 1 = $123,000

Cumulative cash flow in year 2 = $246,000

Cumulative cash flow in year 3 = $369,000

Cumulative cash flow in year 4 = $492,000

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

Payback period= 4 years + ($497,000 - $492,000) / $123,000

= 4 years + $5,000 / $123,000

  = 4 years + 0.0407

                        = 4.04 years.

b.Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$497,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 11.2%.
• Press the down arrow and CPT buttons to get the net present value.  

Net Present value of cash flows at 11.2% the cost of capital is $221,340.59.

The project generates a positive net present value and therefore, would increase the value of the company and I would take the project.