A proposed new venture will cost $85,000 and should produce annual cash flows of $30,000, $55,000, $40,000, and $40,000 for Years 1 to 4, respectively. The discount rate is 10 percent. What is the discounted payback period? What is IRR?
(1)
Discounted payback period (DPBP) is the year when the project's cumulative discounted cash flow is zero.
Year | Cash Flow ($) | PV Factor @10% | Discounted Cash Flow ($) | Cumulative Discounted Cash Flow ($) |
0 | -85,000 | 1.0000 | -85,000 | -85,000 |
1 | 30,000 | 0.9091 | 27,273 | -57,727 |
2 | 55,000 | 0.8264 | 45,455 | -12,273 |
3 | 40,000 | 0.7513 | 30,053 | 17,780 |
4 | 40,000 | 0.6830 | 27,321 | 45,100 |
DPBP lies between years 2 and 3.
DPBP = 2 + (Absolute value of cumulative discounted cash flow, year 2 / Discounted cash flow, year 3)
= 2 + (12,273 / 30,053)
= 2 + 0.41
= 2.41 years
(2)
IRR is computed using Excel IRR function as follows.
Year | Cash Flow ($) |
0 | -85,000 |
1 | 30,000 |
2 | 55,000 |
3 | 40,000 |
4 | 40,000 |
IRR = | 31.90% |
A proposed new venture will cost $85,000 and should produce annual cash flows of $30,000, $55,000,...
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