Question

Ne Present Value and Other Capital Budgeting Measures 5. Consider a project that has the following cash flows: initial cash flow (t-0) --$100,000; cash flows years 1 to 5 (t-1-5) - $10,000 per year, cash flows years 6 to 10 (t-6-10) - $20,000 per year. If the required return on the project is 6%, calculate the following: a. Internal Rate of Return (IRR)? b. Net Present Value (NPV)? c. Profitability index (PI)? d. Payback period?

Please use Excel to solve!

Answer 1

Initial Investment = $100,000
Cash Flows, Year 1 to Year 5 = $10,000
Cash Flows, Year 6 to Year 10 = $20,000

Answer a.

Let IRR be i%

NPV = -$100,000 + $10,000/(1+i) + $10,000/(1+i)^2 + $10,000/(1+i)^3 + $10,000/(1+i)^4 + $10,000/(1+i)^5 + $20,000/(1+i)^6 + $20,000/(1+i)^7 + $20,000/(1+i)^8 + $20,000/(1+i)^9 + $20,000/(1+i)^10
0 = -$100,000 + $10,000/(1+i) + $10,000/(1+i)^2 + $10,000/(1+i)^3 + $10,000/(1+i)^4 + $10,000/(1+i)^5 + $20,000/(1+i)^6 + $20,000/(1+i)^7 + $20,000/(1+i)^8 + $20,000/(1+i)^9 + $20,000/(1+i)^10

Using financial calculator, i = 6.90%

Internal Rate of Return = 6.90%

Answer b.

Required Return = 6.00%

Present Value of Cash Inflows = $10,000/1.06 + $10,000/1.06^2 + $10,000/1.06^3 + $10,000/1.06^4 + $10,000/1.06^5 + $20,000/1.06^6 + $20,000/1.06^7 + $20,000/1.06^8 + $20,000/1.06^9 + $20,000/1.06^10
Present Value of Cash Inflows =                $105,078.10

Net Present Value = Present Value of Cash Inflows - Initial Investment
Net Present Value = $105,078.10 - $100,000
Net Present Value = $5,078.10

Answer c.

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $105,078.10 / $100,000
Profitability Index = 1.05

Answer d.

Company will recoup initial investment of $90,000 in first seven years and remaining $10,000 in 8th year.

Payback Period = 7 + $10,000 / $20,000
Payback Period = 7.50 years