Question

Question #1 Consider the following potential investment, which has the same risk as the firm’s other projects:

Time	CF
0	($700,000)
1	$175,000
2	$195,000
3	$200,000
4	$210,000
5	$220,000
6	$235,000

a) What are the investment’s payback period, IRR, and NPV, assuming the firm’s WACC is 12%?

b) If the firm requires a payback period of less than 3 years, should this project be accepted? Be sure to justify your choice.

c) Based on the IRR and NPV rules, should this project be accepted? Be sure to justify your choice.

d) Which of the decision rules (payback, NPV, or IRR) do you think is the best rule for a firm to use when evaluating projects? Be sure to justify your choice.

Answer 1

Year Calculatiam's EWACC = 12% (Descaunt Rate / Initial Investment = $700.000 (Year o Cash outflowe) b. Annual Cashflowe's Pv = Cashflow (1+ Discount Rate / Year Cashflows Cumulative Present Valus @ 121. (im $) Cashflow 175.000 175.000 156,250 (t.12,7 195.000 370.000 15.5.4.53 200.000 570,000 142.356 210.000 780,000 133 459 | 220,000 1,000,000 124.834 16 235.000 1.235.000 119,058 235.00%) 175.000 la k sw N - 195.000 2 Tit.12 200.00 3 7.12 210.00041 1 7 ./2 ) 220,000S 7 . /2 ) 5 (17./ 26 Present Value of Annual = $831,410 Cashflow's + the Tayleack - Year before Periad full Recovery start Chrecauered Cast at of the Year Cashflow during the year 700.000 - S 70.000 210,000 = 3.62 period Year's is 3.62 Year's Payback

U NPV CNet Present Salue) NPV = Present Value of – Annual Cashflow's Initial Investment = = $ 83L410 - $ 700.000 $ 131.410 ner of the Project is $131.410

(11) IRR (By tris & Errar Methad NPV INPV @ 18% is @ 19% is $1608 $16.891 (Lower l Higher hotel Late IRR = Lover & Rate Difference in Boles NPV at lower Rate & NPV at - Nev at lawer Rate Higher Rate = 181 t x ( 19-18) 1608 1.608 - (-16.891) - 3 18.09_%_ IRR of the project is 18.09% 19) Paylack Periad = 3.62 years NPV = $ 131.410 IRR = 18.09%

3.62 cbs Payleack Periad of the project is 3.62 years - If the firm recquired a Paylack Periad of 4 Less than 3 years. So We should not accept Paraject leccause - Payleack Periad is more than 3 years.

IRR of the praject is 18.09%. Which is Mare than the WACC 12% So Project should be accepted. NPV of the Project is $131.410 NPV of the project is Positive So project should be Accepted.

d) NPV Decisian rule is best for the firm because Rayhack periad does not take Interest Rate ( WACC) into Cansideratiam far cualuatiam. It ignore Time Value of Money. There may be multiple IRR of the Project NPV Consider the time Value of money, and gine ans in absolute money term