Question

Chap 8-Net Present Value la. Amond Ltd has a payback period limit of three years and is considering investing in one of the following projects. Both projects require an initial investment of $800,000. Cash inflows accrue evenly throughout the year. Project Alpha Yeart Cash inflow 1 250,000 2 250,000 3 400,000 4 300,000 5 200,000 6 50,000 Project Beta Year Cash inflow 250,000 350,000 400,000 200,000 150,000 150,000 4 Company's cost of capital is 10%. Calculate the Payback period for the above projects a. b. Calculate the Net Present Value of the above projects Calculate the Internal Rate of Return for the above projects c. 1b Calculating Payback. What is the payback period for the following set of cash flows?

Answer 1

a. Payback period is the number of years in which the initial investment on a project is recovered.

For Project Alpha, amount recovered upto year 2 = $250000 + $250000 = $500000

Balance investment to be recovered in year 3 = $800000 - $500000 = $300000

Payback period = 2 + $300000 / $400000 = 2.75 years

For Project Beta, amount recovered upto year 2 = $250000 + $350000 = $600000

Balance investment to be recovered in year 3 = $800000 - $600000 = $200000

Payback period = 2 + $200000 / $400000 = 2.50 years

b. NPV = Present value of cash inflows - Cash outflows

NPV of both projects is calculated below:

		Alpha		Beta
Year	PV factor	Cash flows	Present value	Cash flows	Present value
0	1	-800000	-800000	-800000	-800000
1	0.909091	250000	227272.73	250000	227272.73
2	0.826446	250000	206611.57	350000	289256.20
3	0.751315	400000	300525.92	400000	300525.92
4	0.683013	300000	204904.04	200000	136602.69
5	0.620921	200000	124184.26	150000	93138.20
6	0.564474	50000	28223.70	150000	84671.09
NPV			291722.22		331466.83

c. IRR is that rate at which NPV is zero. Trying various rates in the above table, we get

IRR Project Alpha = 23%

IRR Project Beta = 24.95%