Question

34-39 Assume that you are a financial analyst for Tangshan Mining Company and are given the following about the firnn's new project: the project's initial after-tax cost at t-o is S8,000,000 and are a financial analyst for Ta the e project is expected to provide after-tax operating cash inflows as follows: Year One Two Three Four Cash In flow: $2,800.000 $2,900,000 $3.200,000 si .800.000 a. Calculate the payback period for this project 1. If the maximum acceptable payback period is 3 years, should this project be accepted? Why or why not? b. Assume that the firm's "Weighted Average Cost ofCapital"(WACC)S6%, Calculate the Net Present Value (NPV) for the above project. 1. Based on your NPV calculations above, should this project be accepted? Why or why not?

Answer 1

Given:
Firm's initial after tax cost of the project CF) = $8,000,000

After tax operating cash flows are also provided.

Payback period is the time or number of periods/years required to recover the initial cost. It is calculated as follows

Payback period is calculated by deducting the cash flows of each year from the remaining investment.

	Cash Flows	Cumulative Cash flow	Calculation
Year 0	-8000000	-8000000	-8000000
Year 1	2800000	-5200000	-8000000+2800000
Year 2	2900000	-2300000	-5200000+2900000
Year 3	3200000	900000	-2300000+3200000
Year 4	1800000

It is between 2 and 3 years the net invested cash has become positive . SO the payback period is 2 years and ( -2300000 / 3200000 = 0.7 years) . Therefore, the payback period is 2.7 years.

1. The payback period is 2.7 years which is less than the cut off 3 years. Hence, the project must be accepted.

b. NPV is the sum of the present value of all the cash inflows and outflows.

NPV = - CF0 + CF1 / (1+r) + CF2 / ( 1+ r) ^2 + CF3 / ( 1+ r)^3 + CF4 / ( 1 + r) ^4

NPV = - 8000000 + 2800000 / 1.06 + 2900000 / 1.06^2 + 3200000 / 1.06^3 + 1800000/1.06^4

NPV = -8000000 + 2641509 + 2580990 + 2686782 + 1425769

NPV = $1335049

NPV of the project is $1335049

1. Yes, the project should be accepted. This is because the NPV is positive and this indicates the the present value of all the cash inflows of the project is greater than its investment. Thus, the project will add value to the company, hence should be accepted.