Question

Problem 8-26 Investment Criteria (L01, 2, 4) If you insulate your office for $22,000, you will save $2,200 a year in heating expenses. These savings will last forever a. what is the NPV of the investment when the cost of capital is 5%? 10%? Cost of Capital 5% 10% NPV b. What is the IRR of the investment? (Enter your answer as a whole percent.) IRR c. What is the payback period on this investment? Payback period years

Answer 1

a.

Cost of Capital

NPV

5%

$ 22,000

10%

0

Working:

# 1

NPV at 5%

Present value of cash inflows

=

$       2,200

/

5%

=

$       44,000

Less cost of investment

$       22,000

NPV

$       22,000

# 2

NPV at 10%

Present value of cash inflows

=

$       2,200

/

10%

=

$       22,000

Less cost of investment

$       22,000

NPV

0

b.

IRR

10%

IRR is the rate at which NPV is zero.At 10%, NPV is zero.So, IRR is 10%.

c.

Payback period

10 Years

Working:

Payback period is the time within which cost of project is recovered back.

Payback period

=

Investment/Annual Cash inflows

=

$       22,000

/

$       2,200

=

10 Years