Question

e 32% A 2:13 PM Individual Assignmen...1 (Feb to July 2019) - Read-only Sign in to edit and save changes to this file Q2. Doorpane produces door panels for the Indonesia housing market Its management is considering three investment projects for the next years. The company's policy is not to invest in projects that requires more than three years to recover the company's initial investment. The cash flows for the three projects Project Belian, Project Kapur and Project Merbau) are as follows: Year Project Belian $ Project Kapur $ Project Merbau $ 600 300 200 100 500 5,000 3,000 3,000 3,000 3,000 1,000 1,000 2,000 2,000 2,000 (a) Given Doorpane's three-year payback period, which of the projects will qualify for acceptance? (b) Rank the projects using their payback periods. Which project looks the best usingg this criterion? Do you agree with this ranking? Why or why or not? (c) If Doorpane uses a 10 percent discount rate to analyse projects, what is the discounted payback period for each of the three projects? If the firm still maintains its three-year payback policy for the discounted payback, which projects should the firm undertake? END -

Answer 1

SOLUTION

A)

Given the 3 year payback policy of Doorpane, Project "Bellan" will qualify for acceptance.

Calculation is provided below

Note: Payback period is a simple calculation of time for the initial investment to return.It ignores the

time value of money.

Step 1 : We will calculated the cumulative cash flow for all the three projects.

Project Bellan $ Project Kapur $ Project Merbau$ YearTotal flow Cumulative flow Total flow Cumulative flow 10000 -5000 -2000 1000 Total flow Cumulative flow 0 -1000 600 300 200 100 500 -1000 10000 -5000 1000 1000 -5000 2 -100 100 200 700 3000 3000 3000 3000 -3000 -1000 1000 3000 4

Step 2 : We will now pick the year in which the outflows have become positive. In other words, the

year with the last negative outflow has to be selected. So, in this case, Project Merbau will get

disqualified as the payback period is more than 3 years. Project Bellan and Project Kapur will be

evaluated further as the payback is less than 3 years. Year 2 is the last year with negative outflows.

Step 3: We will now divide the total cumulative flow of above two projects in the year in which the

cash flows became positive by the total flow of the consecutive year.

Project Bellan$ Project Kapur$ Year Total flow Cumulative flowTotal flow Cumulative flow C) 1 2 INK) -1000 300 200 100 500 -100 100 冰K) ARI 100/200 0.5 5000 3000 3000 AKK) 2000 INK) 생(XX) 7000 4 AKK) -2000/3000 0.67

Step 3: Step 1 + Step 2 = The payback period

Project Bellan Project Kapur 2.67 years Payback period

Step 4: As computed in Step 3, the payback period of Project Bellan (2.5 years) is less than that of

Project Kapur (2.67 years) and hence Project Bellan will be selected for investment.

===========================================================================

B)

Ranking the projects based on their payback periods, Project Bellan looks the

best. Workings provided below. However, as the time value of money has been ignored, we

should not agree to investment in Project Bellan.

Project Bellan $ Project Kapur $ Project Merbau $ Year Total flow Cumulative flow Total flow Cumulative flow Total flow Cumulative flow 0 1000 600 300 200 100 500 1000 10000 5000 3000 3000 3000 3000 10000 1000 100 100 200 700 -100/200 0.5 2 1000 3000 1000 1000 3000 -1000/2000 0.5 1000 4 -2000/3000 0.67 Project Bellan 2.5 years Project Kapur 2.67 years Project Merbau 3.5 years Payback period Rank

===========================================================================

C)

If the payback periods are calculated based on discounted payback method and

3 year payback criteria, none of the project will qualify for investment. Workings provided

below:

Project Bellan $ Project Kapur $ Project Merbau$ Discounting Discounted Cumulative Cash flow Discounted Cumulative Cash flow Discounted Cumulative Cash flow Yearfactor Total flow flow Total flow flow Total flow flow 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 Last year of negative cash flow 1000 -1000 1000 10000 10000 10000 -4091 3264 1762 396 600 1000 909 826 1503 1366 1242 -455 248 3000 3000 3000 3000 2479 2975 -721 1328 3191 1000 200 100 500 4 2049 310 322 1863 4 Part of the year when cash flow turns positve Calculation Total 0.82 56/68 3.82 0.35 0.32 -721/2049 396/1242 3.35 4.32