Question

Use investment criteria and capital budgeting techniques to evaluate the following project. The project involves equipment that costs $300,000 and will last five (5) years before it must be replaced. The 5 year project is expected to produce after-tax cash flows of $60,000 in the first year, and increase by $20,000 annually; the after-tax cash flow in year 5 will reach $140,000. The equipment will have no salvage value after five-years. The discount rate is 15%. Do not forget to show your work.

A. What is the payback period?

B. What is the discounted payback period?

C. What is the IRR?

D. What is the NPV?

E. What is the Profitability Index?

F. What do the investment criteria say about accepting or rejecting the project?

Answer 1

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Part A
Year	Cash Inflow	Cummulative Cash Inflow
1	$                                      60,000	$                                     60,000
2	$                                      80,000	$                                   140,000
3	$                                    100,000	$                                   240,000
4	$                                    120,000	$                                   360,000
5	$                                    140,000	$                                   500,000
Payback Period	Years before Recovery+	Unrecovered Cost at start of the year/Cash Flow during the Next year
	Years before Recovery	3
	Unrecovered Cost	$300,000-$240,000	$                                      60,000
	Cash Flow during year 4		$                                   360,000
Payback Period	3+($60,000/$360,000)
	3.17	Years
Part B
Year	Cash Flow	PVF 15%	Discounted Cash Flow	Cumulative DCF
0	$                                  -300,000	1.00000	$                                  -300,000	$                  -300,000
1	$                                      60,000	0.86957	$                                      52,174	$                  -247,826
2	$                                      80,000	0.75614	$                                      60,491	$                  -187,335
3	$                                    100,000	0.65752	$                                      65,752	$                  -121,583
4	$                                    120,000	0.57175	$                                      68,610	$                    -52,973
5	$                                    140,000	0.49718	$                                      69,605	$                      16,632
Discounted Payback Period	4 Year+(52,973/69,605)	4.76	Years
Part c
Year	Cash Flow
0	$                                  -300,000
1	$                                      60,000
2	$                                      80,000
3	$                                    100,000
4	$                                    120,000
5	$                                    140,000
	IRR(B36:B41)
IRR	17.01%
Part d
Year	Cash Flow	PVF 15%	Discounted Cash Flow
0	$                                  -300,000	1.00000	$                                  -300,000
1	$                                      60,000	0.86957	$                                      52,174
2	$                                      80,000	0.75614	$                                      60,491
3	$                                    100,000	0.65752	$                                      65,752
4	$                                    120,000	0.57175	$                                      68,610
5	$                                    140,000	0.49718	$                                      69,605
Net Present Value			$                                      16,632