Question

You are analysing a project and have prepared the following data:

Year         Cash flows

0             -$275,000

1                 $ 50,000

2                $ 75,000

3                $ 95,000

4                 $ 15,000

Required payback period 3 years

   Required rate of return 5%

a) Determine the project’s Profitability Index, Internal Rate of Return, NPV and Discounted Payback Period                                                                                                                                                    [40 Marks]

b) Decide whether accept the project based on the above investment decision criteria?          [5 Marks] [Total: 45 Marks]

Please provide full steps (No excel sheet)

Answer 1

a) Profitability index =PV of cash flows/Initial Investment =(50000/1.05+75000/1.05^2+95000/1.05^3+15000/1.05^4)/275000
=0.76

IRR using financial calculator
CF0=-275000;CF1=50000;CF2=75000;CF3=95000;CF4=15000;CPT IRR =-6.48%

NPV =PV of cash flows -Initial Investment =(50000/1.05+75000/1.05^2+95000/1.05^3+15000/1.05^4)-275000
=-64948.63

PV of Cash flow 1 =50000/1.05 =47619.05
PV of Cash flow 2 =75000/1.05^2 =68027.21
PV of Cash flow 3 =95000/1.05^3=82064.57
​​​​​​​PV of Cash flow 4 =15000/1.05^4 =12340.54
​​​​​​​Adding all cash flows we get =47619.05+68027.21+82064.57+12340.54=210051.37
Since PV of cash flows is not greater than initial investment the the project will never payback.

b) Since Profitability index is less than 1 project should be rejected.
Since IRR is less than discount rate project should be rejected.
Since NPV is negative project should be rejected.
Based on discounted payback period project should be rejected.