Question

Consider a hypothetical economy that has NO tax. ABC Ltd. is considering investing in a 2-year project which is expected to generate the following year-end cash flows: C = $110 million, C2 = $115 million. The yearly discount rate for the project is 10%. The initial cost of the project is $200 million. (a) Compute the profit and NPV of the project. (4 marks) (6) Based on the answer of part (a), should the project be accepted? Explain. (3 marks) (c) ABC's cut-off period is 2 years. Compute the PI and Payback of the project. Based on these two methods, should ABC accept the project? (6 marks) (d) Write down the numerical formula for computing the IRR of this project. What is the minimum IRR value that would make this project acceptable? Explain. (5 marks)

Answer 1

1.
Profit=110+115-200=25 million

NPV=-200+110/1.10+115/1.10^2=-4.958677686 million

2.
No as NPV is negative the project should not be accepted

3.
PI=1-4.958677686/200=0.975206612

Payback=1+(200-110)/115=1.782608696 years

According to payback, accept as it is less than cutoff of 2 years'

According to PI, dont accept as it is less than 1

4.
-200+110/(1+r)+115/(1+r)^2=0
Let 1/(1+r) be x
-200+110x+115x^2=0
=>x=-1.8811,0.92454
=>x=0.92454
=>1/(1+r)=0.92454
=>r=8.161%

5.
Dont accept the project

Apologies but I am forbidden to answer more than 4 question