Question

In: Finance

You are evaluating a project based on the following: Initial Investment: $1,250,000 Cash Flows: $275,000 per...

You are evaluating a project based on the following: Initial Investment: $1,250,000 Cash Flows: $275,000 per year for 5 years (end of year) Required Return: 10% Required Payback: 5 Years 1. Would you accept or reject the project based on the Net Present Value (NPV)? 2. Would you accept or reject the project based on the Payback Period? 3. Would you accept or reject the project based on the Discounted Payback Period? 4. Based on your answers to Questions 1-3, would you accept or reject the project? Why? Answer questions and include all work on the submission. Please show all work do not use Excel. Show all calculations. Thank you.

Solutions

Expert Solution

1)

Net present value = Present value of cash inflows - present value of cash outflows

Net present value = Annuity * [1 - 1 / (1 + r)n] / r - Initial investment

Net present value = 275,000 * [1 - 1 / (1 + 0.1)5] / 0.1 - 1,250,000

Net present value = 275,000 * 3.790787 - 1,250,000

Net present value = -$207,533.64

Project should be REJECTED as it has a negative NPV

2)

Payback period = Initial investment / cash flows

Payback period = 1,250,000 / 275,000

Payback period = 4.55 years

Project should be ACCEPTED based on payback as payback is less than 5 years

3)

Present value of year 1 cash flow = 275,000 / (1 + 0.1) = 250,000

Present value of year 2 cash flow = 275,000 / (1 + 0.1)2 = 227,272.7273

Present value of year 3 cash flow = 275,000 / (1 + 0.1)3 = 206,611.5702

Present value of year 4 cash flow = 275,000 / (1 + 0.1)4 = 187,828.7002

Present value of year 5 cash flow = 275,000 / (1 + 0.1)5 = 170,753.3638

Cumulative cash flow for year 0 = -1,250,000

Cumulative cash flow for year 1 = -1,250,000 + 250,000 = -1,000,000

Cumulative cash flow for year 2 = -1,000,000 + 227,272.7273 = -772,727.2727

Cumulative cash flow for year 3 = -772,727.2727 + 206,611.5702 = -566,115.7025

Cumulative cash flow for year 4 = -566,115.7025 + 187,828.7002 = -378,287.0023

Cumulative cash flow for year 5 = -378,287.0023 + 170,753.3638 = -207,533.64

The project does not payback as per discounted payback method. Therefore, project should be rejected.

4)

Project should be REJECTED as it has a negative NPV. We always look at the NPV as the most important criteria.

jeff jeffy answered 1 year ago
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