Question

Project 1 Calculations must be done in Excel

Polycorp is considering an investment in new plant of $3 million. The project will be partially financed by a loan of $2 million, which will be repaid over five years in equal annual end of year instalments at a rate of 6.5 percent pa. The rest of the project will be financed by equity. Assume straight-line depreciation over a five-year life, and no taxes. The project’s cash flows before loan repayments and interest are in the table below. Cost of capital is 12.30% pa (the required rate of return on the project). A salvage value of $190,000 is expected at the end of year five and is not included in the cash flows for year five below.

Year	Year One	Year Two	Year Three	Year Four	Year Five
Net Flows Cash	850,000	970,000	881,500	934,530	945,000

You are required to calculate:

1. PB, the payback and discounted payback in years (to one decimal place)
2. ARR, the accounting rate of return (gross and net) (to two decimal places)
3. PI (present value index or profitability index) (to two decimal places)
4. Is the project acceptable? You must provide a decision or explanation for each of the methods in parts (2) to (7). Why or why not (provide a full explanation)? Also, a brief explanation of your treatment of Salvage Value and Loan Repayments is required.

Answer 1

The project is acceptable as it has a positive NPV and high Profitability Index and its IRR(34%) is way over required rate of return.

Salvage Value is a cashflow at the end of the year and is usually taxable. So are the interest payments, but as tax rate is not provided we can ignore both the tax payment and tax savings.

Good Luck