Question

A proposed new venture will cost $85,000 and should produce annual cash flows of $30,000, $55,000, $40,000, and $40,000 for Years 1 to 4, respectively. The discount rate is 10 percent. What is the discounted payback period? What is IRR?

Answer 1

(1)

Discounted payback period (DPBP) is the year when the project's cumulative discounted cash flow is zero.

Year	Cash Flow ($)	PV Factor @10%	Discounted Cash Flow ($)	Cumulative Discounted Cash Flow ($)
0	-85,000	1.0000	-85,000	-85,000
1	30,000	0.9091	27,273	-57,727
2	55,000	0.8264	45,455	-12,273
3	40,000	0.7513	30,053	17,780
4	40,000	0.6830	27,321	45,100

DPBP lies between years 2 and 3.

DPBP = 2 + (Absolute value of cumulative discounted cash flow, year 2 / Discounted cash flow, year 3)

= 2 + (12,273 / 30,053)

= 2 + 0.41

= 2.41 years

(2)

IRR is computed using Excel IRR function as follows.

Year	Cash Flow ($)
0	-85,000
1	30,000
2	55,000
3	40,000
4	40,000
IRR =	31.90%