Question

Need assistance with Basic ROI, Payback Period, Net Present Value, Internal Rate of Return calculations.

Answer 1

The basic ROI formula is :

= Net profit/ Total investment * 100

It is a profitability ratio, that measures the how much net profit the business is generating.

Payback period : this measures how many days a project required, to recover the amount of investment made in the project.

For example, of the investment in the project is $10,000

CF0 = ($10,000)

CF1= $2,000

CF2= $3,000

CF3= $5,000

The cost of capital is 4.5%

So, the payback period is 3 years, as the project takes 3 years to recover the amount of investment made.

The net present value is the difference between the initial investment made in the project minus the present value of all the cash flows generated in the lifetime of the project.

So, the NPV is :

($80,000) + $22,000/1.045 + $33,000/1.045^2 + $50,000/1.045^3

= $15086.5502

The IRR is the rate at which the NPV is zero,

So,

($10,000) + $2,000/(1 + irr)^1 + $3,000/(1+ irr)^2 $5,000/(1 + irr) ^3 = 0

= 12.9777%

= 12.98 ( ronded off to two decimal places)

The NPV assumes that the cash flows are reinvetsed at the cost of capital, the IRR assumes that the cash flows are reinvested at the IRR.