Question

Please show your work with the formulas written out. Please answer as if you can not use a calculator, or only use a four function calculator (because that is how I have to learn it). Do not just put down the calculator keystrokes I need to see every step and number to learn how to do it.

1. Evaluate a 4-year project costing $25,000 and returning $8000 annually using the payback period technique and a 3- year cutoff. (5) 2. Evaluate the project above using the NPV method and a 12% required rate. (10) 3. Bonus: Evaluate the project in Problem #1 using the IRR method and a 10% required rate. (5)

Answer 1

1. Payback period = Initial Cost / Annual Cash Outflows = 25,000 / 8,000 = 3.125 years or 3 years 1.5 months.

As the payback period exceeds the cutoff of 3 years, the project is not acceptable.

2. NPV : - $ 701

As the NPV is negative, the project is not acceptable.

PVA _{12%, 4 years} = [ { 1 - ( 1 / 1.12 ) ⁴ } / 0.12 ] = 3.03735

NPV = $ 8,000 x 3.03735 - $ 25,000 = - $ ( 701.2)

3. As the required rate of 10 % is less than the IRR of 10.65 %, the project is acceptable.

PV factor for IRR = 25,000 / 8,000 = 3.125

IRR is 10.65 %