Question

A project has the following forecasted cash flows:

Cash    Flows Thousands of dollars

C0       C1        C2        C3

-100      40        60        50

        

The investor expected rate of return is 10%. The cost of capital is 12%.

Required:

1. What will you choose to be the discount rate? Why?
2. Please calculate the payback period (PP) and return on investment (ROI).
3. Please calculate NPV，PVI and IRR..
4. Make decision based on the above calculation and explain the reasons.
5. David said that the profit is the same as the cashflow. Do you think his opinion is right or wrong? Why?

Answer 1

1. we will choose cost of capital=12% as the discount rate because it is the actual cost that has to paid for raising the capital for the capex of the particular project. In other way, my cost of funding for the project is 12%. If we consider cost of capital for the discounting of future cashflows, that give us a right picture.

Pay back period is the breakeven. In how many years, will I recieve my initial investment. In this case, the investor recieves his investment in 2 years ($40,000+$60,000=$100,000)

In all these calculations, we should discount the future cashflows to the present value.

David's statement is incorrect because not all the cashflows are profit, we have to discount it back to present value and then subtract with the investment. The resultant figure is the actual profit. In this case, the actual profit is $19,134.9