Question
In: Accounting
The estimated project cost, sales, rent, selling price and production and selling costs of the product...
The estimated project cost, sales, rent, selling price and production and selling costs of the product of a new project are given below. Compute the NPV and payback period of the project. Assume the costs are incurred at the beginning of the year, zero depreciation, no taxes, and discount rate as 10%, Show all calculations.
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | |
| Project cost (Rs. Million) | 40 | 70 | ||||
| Rent for land, buildings and machinery (Rs. Million) | 3 | 40 | 5 | 5 | 6 | 6 |
| Sales (Million Units) | 2 | 2 | 3 | 3 | 4 | |
| Selling Price (Rs./Unit) | 35 | 35 | 40 | 40 | 45 | |
| Production and Selling Costs (Rs. Million) | 18 | 20 | 22 | 22 | 30 |
Solutions
Expert Solution
| Computation of NPV and Payback period | |||||||||
| Sl. No | Particulars | Source | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Total |
| A | Discount factor at 10% | See Formula given | 1 | 0.9091 | 0.8264 | 0.7513 | 0.683 | 0.6209 | NA |
| B | Project Cost (in Million) | Given in question | ₹ 40.00 | ₹ 70.00 | ₹ 0.00 | ₹ 0.00 | ₹ 0.00 | ₹ 0.00 | ₹ 110.00 |
| C | Discounted project cost | B * A | ₹ 40.00 | ₹ 63.64 | ₹ 0.00 | ₹ 0.00 | ₹ 0.00 | ₹ 0.00 | ₹ 103.64 |
| D | Rent for land, building and machinery | Given in question | ₹ 3.00 | ₹ 40.00 | ₹ 5.00 | ₹ 5.00 | ₹ 6.00 | ₹ 6.00 | ₹ 65.00 |
| E | Discounted cost of (D) | D * A | ₹ 3.00 | ₹ 36.36 | ₹ 4.13 | ₹ 3.76 | ₹ 4.10 | ₹ 3.73 | ₹ 55.08 |
| F | Total Cash outflow | E + C | ₹ 43.00 | ₹ 100.00 | ₹ 4.13 | ₹ 3.76 | ₹ 4.10 | ₹ 3.73 | ₹ 158.71 |
| G | Sales Units (in Million) | Given in question | ₹ 0.00 | ₹ 2.00 | ₹ 2.00 | ₹ 3.00 | ₹ 3.00 | ₹ 4.00 | ₹ 14.00 |
| H | Selling price per unit | Given in question | ₹ 0.00 | ₹ 35.00 | ₹ 35.00 | ₹ 40.00 | ₹ 40.00 | ₹ 45.00 | ₹ 195.00 |
| I | Production and Selling cost (In million) | Given in question | ₹ 0.00 | ₹ 18.00 | ₹ 20.00 | ₹ 22.00 | ₹ 22.00 | ₹ 30.00 | ₹ 112.00 |
| J | Operational Profit | (G*H) - I | ₹ 0.00 | ₹ 52.00 | ₹ 50.00 | ₹ 98.00 | ₹ 98.00 | ₹ 150.00 | ₹ 448.00 |
| K | Discounted Cash inflow | J * A | ₹ 0.00 | ₹ 47.27 | ₹ 41.32 | ₹ 73.63 | ₹ 66.93 | ₹ 93.14 | ₹ 322.29 |
| I | Net present Value | Total (K) - Total (F) | -₹ 43.00 | -₹ 52.73 | ₹ 37.19 | ₹ 69.87 | ₹ 62.84 | ₹ 89.41 | ₹ 163.58 |
| Payback period = The period required to recover the project cost | |||||||||
| Payback period (Normal) | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Total | ||
| Project cost | ₹ 40.00 | ₹ 70.00 | ₹ 0.00 | ₹ 0.00 | ₹ 0.00 | ₹ 0.00 | ₹ 110.00 | ||
| Cashflow in each year | -₹ 40.00 | ₹ 52.00 | ₹ 50.00 | ₹ 98.00 | ₹ 98.00 | ₹ 150.00 | ₹ 448.00 | ||
| Cumulative cashflow | -₹ 40.00 | ₹ 12.00 | ₹ 62.00 | ₹ 160.00 | ₹ 258.00 | ₹ 408.00 | ₹ 856.00 | ||
| Therefore payback period = | (Total Project cost - 3rd year cashflow)/((4th year's cumulative cashflow - 3rd year cumulative cashflow)/12 months) | ||||||||
| Plus | |||||||||
| 3 years | |||||||||
| = | (110-62)/(160-62)/12 = | 5.88 months | Plus 3 years | ||||||
| Therefore, Payback period = 3 years and 5.88 months (approx) | |||||||||
| Note: Formula for Discount factor = 1 / (1 x (1 + Discount Rate) ^ Period Number) | |||||||||
| Since question does not mention about if it discounted or normal pay back period, normal pay back period is computed | |||||||||
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