Question

Problem 5 (12 marks) Assume that you are an investor, and the management of Bitter Inc. and Sour Inc. has approached you asking for an investment of $480,000 and $530,000 respectively. The management has offered the following expected cashflows in the future: Sour Inc. Year Bitter Inc. 17.400 2 24.800 51.300 73.600 82.000 99.000 112.000 S 119.000 9 126.900 10 101.000 11 99.500 76.900 600 19,000 61,000 78.000 108.000 141.000 172.000 185.000 199.000 103.000 45.000 33.0

Answer 1

First we calculate Adjusted cash flow of Bitter Inc in Year 08 = Cash Flow - Additional Investment Required = 119000-45000 = 74,000

Adjusted cash flow of Sour Inc in Year 10 = Cash Flow - Additional Investment Required = 119000- 45000 = 161,000

Ans 01 : Calculation of NPV

• PV of Cash Flow = Cash Flow / ( 1 + 6%) ^ Year
• NPV = Sum of PV of Cash Flow

NPV of Bitter Inc 197,442.56

NPV of Sour Inc   176,198.07

Ans : NPV of Bitter Inc is better .

Ans 02 : Calculation of Payback Period :

CumulativeCash Flow(Y – 1) Pay Back Period = (Y – 1) +- Cash FlowY

Y = cumulative cash flows become positive

Bitter Inc :

Y = cumulative cash flows become positive = 8

Cumulative Cash Flow (Y-1 ) = (We will take Positive Value Here for Calculation) = 19,900

Cash Flow Y =   74,400

Payback Period = ( 8 - 1) +     19,900 / 74,400 =   7 + 0.2689 = 7.2689

Sour Inc :

Y = cumulative cash flows become positive = 8

Cumulative Cash Flow (Y-1 ) = (We will take Positive Value Here for Calculation) = 123,000

Cash Flow Y =   172,000

Payback Period = ( 8 - 1) +     123,000 / 172,000 =   7 + 0.7151 = 7.7151

Payback Period Bitter Inc      7.2689

Payback Period of Sour Inc   7.7151

Ans Payback Period of Bitter Inc is Better.

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Ans 03 : Calculation of Discounted Payback Period :

$Discounted Pay Back Period = (Y -1) + \frac{Discounted Cumulative Cash Flow (Y-1)}{Discounted Cash Flow Y}$

Y = cumulative Discounted cash flows become positive

Bitter Inc :

Y = Discounted   cumulative cash flows become positive = 10

Cumulative Cash Flow (Y-1 ) = (We will take Positive Value Here for Calculation) = 13,049.34

Cash Flow Y =   56,397.87

Discounted   Payback Period = ( 10 - 1) +     13,049.34/ 56,397.87 = 9 + 0.2313 = 9.2313

Sour Inc :

Y = Discounted   cumulative cash flows become positive = 9

Cumulative Cash Flow (Y-1 ) = (We will take Positive Value Here for Calculation) = 20,118.45

Cash Flow Y =   89,901.56

Discounted   Payback Period = ( 9 - 1) +     20,118.45 / 89,901.56 = 8 + 0.2237 = 8.2237

Discounted    Payback Period Bitter Inc    9.2313

Payback Period of Sour Inc   8.2237

Ans Payback Period of Sour Inc is Better.

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