Question

#1 Cash Payback Period, Net Present Value Method, and Analysis for a Service Company

Social Circle Publications Inc. is considering two new magazine products. The estimated net cash flows from each product are as follows:

Year	Sound Cellar			Pro Gamer
1		$ 65,000			$ 70,000
2		60,000			55,000
3		25,000			35,000
4		25,000			30,000
5		45,000			30,000
Total		$220,000			$220,000

Each product requires an investment of $125,000. A rate of 10% has been selected for the net present value analysis.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1a. Compute the cash payback period for each product.

	Cash Payback Period
Sound Cellar
Pro Gamer

1b. Compute the net present value. Use the present value of $1 table above. If required, round to the nearest dollar.

	Sound Cellar	Pro Gamer
Present value of net cash flow total	$	$
Amount to be invested	$	$
Net present value	$	$

2. Because of the timing of the receipt of the net cash flows, the   magazine expansion offers a higher  .

#2 Net Present Value Method, Internal Rate of Return Method, and Analysis for a Service Company

The management of Style Networks Inc. is considering two TV show projects. The estimated net cash flows from each project are as follows:

Year		After Hours		Sun Fun
1		$320,000		$290,000
2		320,000		290,000
3		320,000		290,000
4		320,000		290,000

After Hours requires an investment of $913,600, while Sun Fun requires an investment of $880,730. No residual value is expected from either project.

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.352	2.991
6	4.917	4.355	4.111	3.784	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

Required:

1a. Compute the net present value for each project. Use a rate of 10% and the present value of an annuity of $1 in the above table. If required, round to the nearest dollar.

	After Hours	Sun Fun
Present value of annual net cash flows	$	$
Amount to be invested	$	$
Net present value	$	$

1b. Compute a present value index for each project. If required, round your answers to two decimal places.

	Present Value Index
After Hours
Sun Fun

2. Determine the internal rate of return for each project by (a) computing a present value factor for an annuity of $1 and (b) using the present value of an annuity of $1 table above. If required, round your present value factor answers to three decimal places and internal rate of return to the nearest percent.

	After Hours	Sun Fun
Present value factor for an annuity of $1
Internal rate of return	%	%

3. The net present value, present value index, and internal rate of return all indicate that the   TV show is a better financial opportunity compared to the   TV show, although both investments meet the minimum return criterion of 10%.

Answer 1

Social Circle Publications Inc.

1a.

Payback period:
Sound Cellar		2 year
Pro Gamar		2 year

Working:

	Sound	Pro	Payback Amount		Payback period
Year	Celler	Gammer	Celler	Gammer	Celler	Gammer
1	$       65,000.00	$      70,000.00	$ 65,000.00	$ 70,000.00	1	1
2	$       60,000.00	$      55,000.00	$ 60,000.00	$ 55,000.00	1	1
3	$       25,000.00	$      35,000.00
4	$       25,000.00	$      30,000.00
5	$       45,000.00	$      30,000.00
Total	$     220,000.00	$     220,000.00	$125,000.00	$125,000.00	2	2

1b.

			Sound	Pro
			Celler	Gammer
Present Value of Net Cash flow			172440	174465
Less: Amount Invested			125000	125000
Net Present Value			47440	49465

Working:

	Sound	Pro	PV Factor	Present Value
Year	Celler	Gammer	at 10%	Celler	Gammer
1	65000	70000	0.909	59085	63630
2	60000	55000	0.826	49560	45430
3	25000	35000	0.751	18775	26285
4	25000	30000	0.683	17075	20490
5	45000	30000	0.621	27945	18630
Total	220000	220000		172440	174465

2.

Because of the timing of the receipt of the net cash flows, the Pro Gamar magazine expenses offer a higher Net Present Value.

Style Network Inc.

1a.

1a. NPV = sum of all present values (PV). PV = amount of cash flow*present value of annuity at 10% for the applicable year.

NPV of after hours = (present value of cash flows from years 1 to 4) - initial investment.

present value of cash flows from years 1 to 4 = annual cash flows of 320,000*PV of annuty at 10% and 4 years = 320,000*3.17 = $1,014,400.

Thus NPV = $1,014,400 - 913,600 = $100,800

Sun Fun: present value of cash flows from years 1 to 4 = 290,000*3.17 = $919,300. Thus NPV = 919,300 - 880,730 = 38,750

	After Hours	Sun Fun
Present value of annual net cash flows	1,014,400.00	919,300.00
Less amount to be invested	-913,600.00	-880,730.00
Net present value	100,800.00	38,570.00

1b.

1b. Present value Index = Present value of future cash flows/Initial investment

After hours = 1,014,400/913,600 = 1.11

Sun Fun = 919,300/880,730 = 1.04

	Present Value Index
After Hours	1.11
Sun Fun	1.04

2.

2. IRR (internal rate of return) is that rate which makes the NPV as nil.

Now this is found using the trial and error method.

For After Hours the IRR is around 15%. From the provided table the PV factor of annuity = 2.855

Similarly for Sun Fun the IRR is 12% and PV factor of annuity = 3.037

	After Hours	Sun Fun
Present value factor for an annuity of $1	2.855	3.037
Internal ra te of return	15	12

3.

The net present value, present value index, and internal rate of return all indicate that the After Hours TV show is a better financial opportunity compared to the Sun Fun TV show.