Question

You are evaluating a project that will cost $493,000, but is expected to produce cash flows of $128,000 per year for 10 years, with the first cash flow in one year. Your cost of capital is 11.3% and your companys preferred payback period is three years or less.

a. What is the payback period of this​ project?

b. Should you take the project if you want to increase the value of the​ company?

If you want to increase the value of the company you WILL or WILL not take the project since the NPV is NEGATIVE or POSITIVE

Answer 1

a
Project
Year	Cash flow stream	Cumulative cash flow
0	-493000	-493000
1	128000	-365000
2	128000	-237000
3	128000	-109000
4	128000	19000
5	128000	147000
6	128000	275000
7	128000	403000
8	128000	531000
9	128000	659000
10	128000	787000
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 3 and 4
therefore by interpolation payback period = 3 + (0-(-109000))/(19000-(-109000))
3.85 Years
Reject project as payback period is more than 3 years
b
Project
Discount rate	0.113
Year	0.00%	1	2	3	4	5	6	7	8	9	10
Cash flow stream	-493000	128000	128000	128000	128000	128000	128000	128000	128000	128000	128000
Discounting factor	1	1.113	1.238769	1.37875	1.5345486	1.707953	1.900951	2.115759	2.35484	2.620936	2.917102
Discounted cash flows project	-493000	115004.5	103328.4	92837.72	83412.149	74943.53	67334.71	60498.39	54356.15	48837.51	43879.16
NPV = Sum of discounted cash flows
NPV Project =	251432.19
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Accept project as NPV is positive