Initial Cost = 250,000
Profit in the 1st year = 30,000, and to grow by 4% each year after that.
a. What is the simple payback period?
Cash Flow |
Net Cash Flow |
|
Year 0 |
$-250,000.00 |
$-250,000.00 |
Year 1 |
$30,000.00 |
$-220,000.00 |
Year 2 |
$31,200.00 |
$-188,800.00 |
Year 3 |
$32,448.00 |
$-156,352.00 |
Year 4 |
$33,745.92 |
$-122,606.08 |
Year 5 |
$35,095.76 |
$-87,510.32 |
Year 6 |
$36,499.59 |
$-51,010.74 |
Year 7 |
$37,959.57 |
$-13,051.17 |
Year 8 |
$39,477.95 |
$26,426.79 |
Simple pay-back period = 7+(13,051 ÷ 39,478) = 7.3 years
Rounding off, Pay back period = 7 years (taking integers)
b. What is discounted payback period at an interest rate of 6%.
Cash Flow |
Discounted Cash Flow |
Net Discounted Cash Flow |
|
Year 0 |
$-250,000.00 |
$-250,000.00 |
$-250,000.00 |
Year 1 |
$30,000.00 |
$28,301.89 |
$-221,698.11 |
Year 2 |
$31,200.00 |
$27,767.89 |
$-193,930.22 |
Year 3 |
$32,448.00 |
$27,243.97 |
$-166,686.26 |
Year 4 |
$33,745.92 |
$26,729.93 |
$-139,956.33 |
Year 5 |
$35,095.76 |
$26,225.59 |
$-113,730.74 |
Year 6 |
$36,499.59 |
$25,730.77 |
$-87,999.97 |
Year 7 |
$37,959.57 |
$25,245.28 |
$-62,754.69 |
Year 8 |
$39,477.95 |
$24,768.96 |
$-37,985.73 |
Year 9 |
$41,057.07 |
$24,301.62 |
$-13,684.11 |
Year 10 |
$42,699.35 |
$23,843.10 |
$10,158.98 |
Discounted payback period = 9+[-13684 – 0 ÷ -13684 – (10159)]*1% = 9.5 years
Rounding off, payback period = 10 years (taking integers)
c) If the company looks for a discounted payback period of 6 years, is it a good investment?
B. No. At a discounted payback period of 6 years, the investment is not good. The investment should be rejected as both the simple payback period and discounted payback period is more than the standard given.
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