Question

The Sampson Company is considering a project that requires an initial outlay of $75,000 and produces cash inflows of $20,806 each year for five years. Sampson’s cost of capital is 10%.

a. Calculate the project’s payback period by making a single division rather than accumulating cash inflows. Why is this possible in this case?

b. Calculate the project’s IRR, recognizing the fact that the cash inflows are an annuity. Is the project acceptable? Did your calculation in this part result in any number(s) that were also calculated in part (a)? What is it about this problem that creates this similarity? Will this always happen in such cases?

c. What is the project’s NPV? Is the project acceptable according to NPV rules?

please do in word file

Answer 1

A.Payback period = Intial payment / Constant future cash inflow

=$75000/ $20806 =3.604729 years

It was possible in this case because future cash inflows were the same and were coming in a regular interval of time.

B. IRR is the rate at which NPV = 0

NPV = initial payment + present value of future cash flow

0 = -$75000 + $20806 * PVFA

PVFA for IRR of 5 years = 3.6047

Using Heat and trial method, IRR = 12.0005 %

The project is acceptable because IRR is higher than the cost of capital of 10%.

Yes, one number was the same i.e. 3.6047.

The PVF factor (=3.6047) was equal to the payback period because there was one cash outflow followed by equal and regular inflow in the project lifecycle which forms an annuity.

OR

You can also calculate IRR using the financial calculator:

PV =-75000

PMT = 20806

N=5

FV=0

CPT I/Y - > IRR = 12.0005%

C.

NPV = initial payment + present value of future cash flow

NPV = -75000 + 20806* (PVFA at 10% for 5years)

= -75000 +20806 * 3.7908

=$ 3871.1095

We will accept the project as NPV is more than 0.

OR

NPV calculation using Finacial calculator:  

2nf -> CF -> CFo = -75000 -> Enter ->down key -> C01 = 20806 -> Enter, similarly C02,C03,C04, C05

Press NPV ->I = 10 -> Enter -> down -> CPT NPV

NPV =$3871.1095

Please let me know in case you have any queries and I will be happy to assist you.