Question

Please show your steps! Question 1 a) What is the NPV, IRR, and payback period of a project with the following cash flows if WACC is 20%? Time: 0 -$350,000 1 $100,000 2 $100,000 3 $100,000 5 $50,000 $50,000 NPV= IRRE Payback period= b) Should you accept or reject the project according to NPV and IRR?

Answer 1

a)

NPV

350,000 - [(100,000/1.20) + (100,000/(1.20)^2) + (100,000/(1.20) ^3) + (50,000/(1.20) ^4) + (50,000/(1.20) ^5)]

= - 95,145.31893

IRR

350,000 - [(100,000/1 + r) + (100,000/(1+r)^2) + (100,000/(1+r) ^3) + (50,000/(1+r) ^4) + (50,000/(1+r) ^5) = 0

= 350,000 = [(100,000/1 + r) + (100,000/(1+r)^2) + (100,000/(1+r) ^3) + (50,000/(1+r) ^4) + (50,000/(1+r) ^5)

on solving the above equation

we get

r = 5.31078 %

payback period

300,000 can be recovered in initial 3 years of cash flow

rest of 50,000 can be recovered in the 4th year

hence 350,000 can be recovered in 4 years

payback period is 4 years .

b) we should reject the project by NPV calculations because we have a negative NPV for this project - 95,145.31893

According to IRR method we should reject the project as the IRR is less than WACC i.e,  5.31078 % < 20 %  

This means that the project is giving less rate of return than the cost of capital of the project .