Question

Generic Motors Corporation is planning to invest $225,000 in year zero (today) in new equipment. This investment is expected to generate net cash flows of $90,000 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=$ investment $ % (enter say 10% as 10, not as 0.1 and not as 10%) SRR

Answer 1

Computation of NPV
Particular	Time	PVF @20%	Amount	PV
Cash ouflow (b))	0	1	-$225,000.00	-$225,000.00
Cash Inflow	1	0.833333333	$90,000.00	$75,000.00
	2	0.694444444	$90,000.00	$62,500.00
	3	0.578703704	$90,000.00	$52,083.33
	4	0.482253086	$90,000.00	$43,402.78
Pvof Inflow (a)				$232,986.11
NPV(a-b)				$7,986.11

Computation of Payback period
Cost of Equipment (a)	225000
Annual Cash Flow (b)	90000
Payback Period (a/b)	2.50	Years

Computation of Simple Rate of Return
Net Income (a) (Annual Cash Flow-Depreciation) (90000-(225000/4))	33,750
Initial Investment ( b)	225,000
Simple ROI	15.0%

Computation of Modified Payback period
Year	Annual Cash Flow	PVF @20%	Present Value	Cumm PV
1	90000	0.833333333	$75,000	$75,000
2	90000	0.694444444	$62,500	$137,500
3	90000	0.578703704	$52,083	$189,583
4	90000	0.482253086	$43,403	$232,986

Modified Payback period= 3+ (225000-189583)/4340= 3.82 year
Hence , Correct answer will be between 3 and 4 year