You are considering making a movie. The movie is expected to cost $ 10.1 million up front and take a year to produce. After that, it is expected to make $ 4.1 million in the year it is released and $ 2.1 million for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10.5 %?
Project | ||
Year | Cash flow stream | Cumulative cash flow |
0 | -10.1 | -10.1 |
1 | 0 | -10.1 |
2 | 4.1 | -6 |
3 | 2.1 | -3.9 |
4 | 2.1 | -1.8 |
5 | 2.1 | 0.3 |
6 | 2.1 | 2.4 |
Payback period is the time by which undiscounted cashflow cover the intial investment outlay | ||
this is happening between year 4 and 5 | ||
therefore by interpolation payback period = 4 + (0-(-1.8))/(0.3-(-1.8)) | ||
4.86 Years | ||
Reject project as payback period is more than 2 years |
Project | |||||||
Discount rate | 0.105 | ||||||
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
Cash flow stream | -10.1 | 0 | 4.1 | 2.1 | 2.1 | 2.1 | 2.1 |
Discounting factor | 1 | 1.105 | 1.221025 | 1.349233 | 1.4909021 | 1.647447 | 1.820429 |
Discounted cash flows project | -10.1 | 0 | 3.357835 | 1.55644 | 1.4085432 | 1.2747 | 1.153574 |
NPV = Sum of discounted cash flows | |||||||
NPV Project = | -1.35 | ||||||
Where | |||||||
Discounting factor = | (1 + discount rate)^(Corresponding period in years) | ||||||
Discounted Cashflow= | Cash flow stream/discounting factor | ||||||
NPV is negative |
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