Question

1. Calculate the payback period for the following investment proposal.
Investment
Annual Net Cash Flows
1
2
3
4
5
6
7
8
9
10
250
86
50
77
52
41
70
127
24
6
40
Payback Period:

2.A 4-year project has a projected cash inflow of $5,000 in the first year, $10,000 in the second year, $15,000 in the third year, and $20,000 in the fourth year. It will cost $19,000 to implement the project. The required rate of return is 25%. What is the NPV?  

Answer 1

Payback period calculation:

Year	Annual net cash flows	Cumulative cash flows
1	86	86
2	50	136
3	77	213
4	52	265
5	41	306
6	70	376
7	127	503
8	24	527
9	6	533
10	40	573

In the above table, we can see that initial investment is recovered between 3^rd and 4^th year i.e., between 213 and 265. Therefore, payback period is computed as follows.

Payback period = 3 + [(250-213) / 41]

= 3 + 10.83

= 3 years and 11 months approximately

2.

Compute NPV of the project:

Year	Annual net cash flows	Discounting factor @ 25%	Discounted cash flows
1	$                             5,000	0.8	$                                   4,000
2	$                           10,000	0.64	$                                   6,400
3	$                           15,000	0.512	$                                   7,680
4	$                           20,000	0.4096	$                                   8,192
		Total cash inflows	$                                26,272
		Less: Initial investment	19000
		NPV	$                                   7,272