Question

Vilas Company is considering a capital investment of $190,700 in additional productive facilities. The new machinery is expected to have a useful life of 5 years with no salvage value. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $15,700 and $50,000, respectively. Vilas has a 12% cost of capital rate, which is the required rate of return on the investment. cash payback period is 3.89 1. Compute the annual rate of return on the proposed capital expenditure. 2Using the discounted cash flow technique, compute the net present value

Answer 1

Formula sheet

A	B	C	D	E	F	G	H	I	J	K
2
3		Initial investment	190700
4		Useful life	5	Years
5		Salvage Value	0
6		Annual Net income	15700
7		Net annual cash flow	50000
8		To calculate NPV and rate of return, free cash flows needs to be calculated.
9		Free Cash Flow for the project can be represented as follows:
10		Year	0	1	2	3	4	5
11		Investment	=-D3
12		Net annual cash flow		=$D$7	=$D$7	=$D$7	=$D$7	=$D$7
13		Terminal disposal value						=D5
14		Free Cash Flow	=SUM(D11:D13)	=SUM(E11:E13)	=SUM(F11:F13)	=SUM(G11:G13)	=SUM(H11:H13)	=SUM(I11:I13)
15
16		Calculation of internal rate of return i.e.IRR for the project:
17		IRR is the rate at which NPV of the project will be zero.
18
19		IRR can be found using IRR function in excel as follows:
20
21		Year	0	=D21+1	=E21+1	=F21+1	=G21+1	=H21+1
22		Cash Flow	=D14	=E14	=F14	=G14	=H14	=I14
23		IRR	=IRR(D22:I22)	=IRR(D22:I22)
24
25		IRR of the project	=D23
26
27		NPV calculation:
28		NPV of the project is present value of future cash flows discounted at required rate of return less the initial investment.
29		Given the following cash flow and WACC, NPV for the project can be calculated as follows:
30		Year	0	1	2	3	4	5
31		Free Cash Flow (FCF)	=D14	=E14	=F14	=G14	=H14	=I14
32		Cost of capital (i)	0.12
33		(P/F,i,n) for each year		=1/((1+$D32)^E30)	=1/((1+$D32)^F30)	=1/((1+$D32)^G30)	=1/((1+$D32)^H30)	=1/((1+$D32)^I30)
34		Present Value of cash flows = FCF*(P/F,i,n)		=E31*E33	=F31*F33	=G31*G33	=H31*H33	=I31*I33
35		Present value if future cash flows	=SUM(E34:I34)	=SUM(E34:I34)
36
37		NPV for Project	=Present value fo future cash flows - Initial investment
38			=D35+D31	=D35+D31
39
40		Hence NPV of the project is	=D38
41