Question

Question 1 (evaluating investment projects) Generic Motors Corporation is planning to invest $150,000 in year zero (today) in new equipment. This investment is expected to generate net cash flows of $60,000 a year for the next 4 years (years 1-4). The salvage value after 4 years is zero. The discount rate (cost of capital) is 20 % a year Required: a) What is the net present value (NPV) of this project? NPV Should the firm invest, based on NPV? (1-yes, 2 no) b) What is the payback period for this project? payback period years c) What is the modified payback period for this project? between 1 and 2 years between 2 and 3 years between 3 and 4 years d) What is the simple rate of return (SRR) for this project? To compute SRR, first compute: annual depreciation $ annual income s investment-$ SRR % (enter say 10% as 10, not as 0.1 and not as 10 %)

Answer 1

Statement showing Present Values Years 1 2 3 Particulars Cash Inflows: Net Cash Inflows Cash Outflows: Initial Investment 60,000 60,000 60,000 60,000 (1,50,000) Inflow/(Outflow) Pv factor @ 20% (b) Present Values (axb) Cumulative Cash Inflows (1,50,000) 1.000 (1,50,000) 60,000 0.833 50,000 50,000 60,000 0.694 41,667 91,667 60,000 0.579 34,722 1,26,389 60,000 0.482 28,935 1,55,324 $ 5,324 Net present Value (sum of All present values) Solution 1. a) NPV of this project is Should the firm invest, based on NPV $ 5,324 YES b) Payback period = Initial Ivestment / Annual Cash Inflows = $150000 / $60000 2.5 years c) The modified payback period of this project is: Between 3 and 4 years d) Annual Depreciation = (Cost - Salvage value) / life of asset = ($150000 - 0)/4 = $ 37,500.00 Annual Income = Net Cash inflows - Depreciation = $60000 - $37500 = $ 22,500.00 Investment = $ 1,50,000.00 SRR (Simple Rate of Return) Annual Income / Investment x100 = $22500 / $150000 x100 15 %

Solution 2. Years 1 | 2 3 Particulars Cash Inflows: Annual Cost savings Cash Outflows: Initial Investment 906045 (150) Inflow/(Outflow) (a) (150) | 90 | 60 | 45 PV for General Motors @ 25% Pv factor @ 25% (b) 1.000 Present Values (axb) (150) a) NPV for General Motors (sum of all Present Values) Should GM invest, based on NPV 0.800 0.640 7238 $-16.56 0.512 23 NO PV for Toyota @ 10% Pv factor @ 10% (c) 1.000 Present Values (axC) (150) b) NPV for Toyota (sum of all Present Values) Should Toyota invest, based on NPV 0.909 82 0.826 50 $ 15.21 0.751 34 YES

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