Question

Explanation textbox:
	Finishing
Hurdle Rate:	16%
Original Cost:	$    (1,600,000)
Net Cash Inflows:
Year 1	$        345,000
Year 2	495,000
Year 3	365,000
Year 4	275,000
Year 5	329,000
Year 6	429,000
Year 7	329,000
Year 8	279,000
Payback period:
Internal Rate of Return:
Net Present Value:
Explanation textbox:

Answer 1

Payback Period, Net Present Value & Internal Rate of Return for Finishing

Payback Period

Year	Cash Flows	Cumulative net Cash flow
0	-16,00,000	-16,00,000
1	3,45,000	-12,55,000
2	4,95,000	-7,60,000
3	3,65,000	-3,95,000
4	2,75,000	-1,20,000
5	3,29,000	2,09,000
6	4,29,000	6,38,000
7	3,29,000	9,67,000
8	2,79,000	12,46,000

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 4 Year + ($120,000 / $329,000)

= 4 Year + 0.36 years

= 4.36 Years

Net Present Value

Year	Annual Cash Inflow ($)	Present Value Factor at 16%	Present Value of Annual Cash Inflow ($)
1	3,45,000	0.86207	2,97,413.79
2	4,95,000	0.74316	3,67,865.64
3	3,65,000	0.64066	2,33,840.05
4	2,75,000	0.55229	1,51,880.05
5	3,29,000	0.47611	1,56,641.18
6	4,29,000	0.41044	1,76,079.73
7	3,29,000	0.35383	1,16,409.92
8	2,79,000	0.30503	85,102.10
TOTAL			15,85,232.46

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $15,85,232.46 - $16,00,000

= -$14,767.54 (Negative NPV)

Internal Rate of Return (IRR)

Step – 1, Firstly calculate NPV at a guessed discount Rate, Say 15%

Year	Annual Cash Flow	Present Value factor at 15%	Present Value of Cash Flow
1	3,45,000	0.86957	3,00,000.00
2	4,95,000	0.75614	3,74,291.12
3	3,65,000	0.65752	2,39,993.42
4	2,75,000	0.57175	1,57,232.14
5	3,29,000	0.49718	1,63,571.15
6	4,29,000	0.43233	1,85,468.54
7	3,29,000	0.37594	1,23,683.29
8	2,79,000	0.32690	91,205.59
TOTAL			16,35,445.25

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $16,35,445.25 - $16,00,000

= $35,445.25

Step – 2, NPV at 15% is positive, Calculate the NPV again at a higher discount rate, Say 16%

Year	Annual Cash Flow	Present Value factor at 16%	Present Value of Cash Flow
1	3,45,000	0.86207	2,97,413.79
2	4,95,000	0.74316	3,67,865.64
3	3,65,000	0.64066	2,33,840.05
4	2,75,000	0.55229	1,51,880.05
5	3,29,000	0.47611	1,56,641.18
6	4,29,000	0.41044	1,76,079.73
7	3,29,000	0.35383	1,16,409.92
8	2,79,000	0.30503	85,102.10
TOTAL			15,85,232.46

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $15,85,232.46 - $16,00,000

= -$14,767.54 (Negative NPV)

Therefore IRR = R1 + NPV1(R2-R1)

                                   NPV1-NPV2

= 0.15 + [$35,445.25 x (0.16 – 0.15)]

              $35,445.25 – (-$14,767.54)

= 0.15 + 0.0071

= 0.1571

= 15.71%