In: Accounting
Cash Payback Period, A method of analysis of proposed capital investments that focuses on the present value of the cash flows expected from the investments.Net Present Value Method, and Analysis
Elite Apparel Inc. is considering two investment projects. The estimated net cash flows from each project are as follows:
Year | Plant Expansion | Retail Store Expansion | ||
1 | $150,000 | $125,000 | ||
2 | 122,000 | 147,000 | ||
3 | 106,000 | 101,000 | ||
4 | 96,000 | 70,000 | ||
5 | 29,000 | 60,000 | ||
Total | $503,000 | $503,000 |
Each project requires an investment of $272,000. A rate of 15% has been selected for the net present value analysis.
Present Value of $1 at Compound Interest | |||||
Year | 6% | 10% | 12% | 15% | 20% |
1 | 0.943 | 0.909 | 0.893 | 0.870 | 0.833 |
2 | 0.890 | 0.826 | 0.797 | 0.756 | 0.694 |
3 | 0.840 | 0.751 | 0.712 | 0.658 | 0.579 |
4 | 0.792 | 0.683 | 0.636 | 0.572 | 0.482 |
5 | 0.747 | 0.621 | 0.567 | 0.497 | 0.402 |
6 | 0.705 | 0.564 | 0.507 | 0.432 | 0.335 |
7 | 0.665 | 0.513 | 0.452 | 0.376 | 0.279 |
8 | 0.627 | 0.467 | 0.404 | 0.327 | 0.233 |
9 | 0.592 | 0.424 | 0.361 | 0.284 | 0.194 |
10 | 0.558 | 0.386 | 0.322 | 0.247 | 0.162 |
Required:
1a. Compute the cash payback period for each project.
Cash Payback Period | |
Plant Expansion | 2 years
|
Retail Store Expansion | 2 years
|
1b. Compute the net present value. Use the present value of $1 table above. If required, round to the nearest dollar.
Plant Expansion | Retail Store Expansion | |
Total present value of net cash flow | $ | $ |
Less amount to be invested | ||
Net present value | $ | $ |
Solution
The information about the cash flows are given below,
Year | Plant Expansion Project | Retail Store Expansion Project |
0 | $ (272,000.00) | $ (272,000.00) |
1 | $ 150,000.00 | $ 125,000.00 |
2 | $ 122,000.00 | $ 147,000.00 |
3 | $ 106,000.00 | $ 101,000.00 |
4 | $ 96,000.00 | $ 70,000.00 |
5 | $ 29,000.00 | $ 60,000.00 |
Now, to determine Cash Payback Period in both the projects, the calculation shall be made as follows,
Year | Plant Expansion Project | Retail Store Expansion Project | ||
Cash Inflows | Cumulative Cash Inflows | Cash Inflows | Cumulative Cash Inflows | |
1 | $ 150,000.00 | $ 150,000.00 | $ 125,000.00 | $ 125,000.00 |
2 | $ 122,000.00 | $ 272,000.00 | $ 147,000.00 | $ 272,000.00 |
3 | $ 106,000.00 | $ 378,000.00 | $ 101,000.00 | $ 373,000.00 |
4 | $ 96,000.00 | $ 474,000.00 | $ 70,000.00 | $ 443,000.00 |
5 | $ 29,000.00 | $ 503,000.00 | $ 60,000.00 | $ 503,000.00 |
As we know that Payback Period means that specific time at which the Initial Investment will be recovered, given Initial Investment = $272,000, we can clearly see that the Initial Investment will be recovered by the end of the 2nd year, i.e. Cumulative Cash Inflow (in both the projects at the 2nd year) = $272,000.
Once we are done with that, let us compute the Net Present Value as follows,
Year | Plant Expansion Project | Retail Store Expansion Project | ||||
Cash Inflows | PVIF @ 15% | Discounted Cash Inflow | Cash Inflows | PVIF @ 15% | Discounted Cash Inflow | |
1 | $ 150,000.00 | 0.870 | $ 130,434.78 | $ 125,000.00 | 0.870 | $ 108,695.65 |
2 | $ 122,000.00 | 0.756 | $ 92,249.53 | $ 147,000.00 | 0.756 | $ 111,153.12 |
3 | $ 106,000.00 | 0.658 | $ 69,696.72 | $ 101,000.00 | 0.658 | $ 66,409.14 |
4 | $ 96,000.00 | 0.572 | $ 54,888.31 | $ 70,000.00 | 0.572 | $ 40,022.73 |
5 | $ 29,000.00 | 0.497 | $ 14,418.13 | $ 60,000.00 | 0.497 | $ 29,830.60 |
Total present value of net cash flow | $ 361,687.47 | $ 356,111.24 | ||||
Less: Amount to be invested | $ (272,000.00) | $ (272,000.00) | ||||
Net present value | $ 89,687.47 | $ 84,111.24 |