Instructions: Please answer questions A-D below. I can\'t award credit if A-D is
ID: 2782406 • Letter: I
Question
Instructions: Please answer questions A-D below. I can't award credit if A-D isn't answered completely.
Primus Corp. is planning to convert an existing warehouse into a new plant that will increase its production capacity by 45 percent. The cost of this project will be $7,125,000. It will result in additional cash flows of $1,875,000 for the next eight years. The company uses a discount rate of 12 percent.
A. What is the payback period?
B. What is the NPV for this project ?
C. What is the IRR?
D. Based on the results give a suggestion to Primas Corp?
Explanation / Answer
Payback Period
Payback is the time it takes for the project to return the initial capital incurred on project.
Since the cash inflow is same through out the year
Payback period = Initial cash out flow/Annual cash inflow
= 7125000/1875000
= 3.8 years
NPV
NPV is the difference between present value of all cash inflow and initial cost of asset or project. All the future cash flows are discounted using discounting rate or required rate and the sum of all the discounted cash flows will be subtracted with initial cost.
NPV = Sum of future cash inflow - initial cost
Pls refer below table for NPV calculation,
Year
Cash Inflow
PV factor
PV of cash flow
1
1875000
0.892857
1674107.143
2
1875000
0.797194
1494738.52
3
1875000
0.711780
1334587.965
4
1875000
0.635518
1191596.397
5
1875000
0.567427
1063925.354
6
1875000
0.506631
949933.3522
7
1875000
0.452349
848154.7788
8
1875000
0.403883
757281.0525
Total
9314324.563
Initial cost
7125000
NPV
2189324.563
Decision rule for NPV is that project is accepted if NPV is positive and rejected if it is in negative
IRR
Internal rate of return is the rate at which if we discount all the future cash flows, the resulting NPV will be zero, it is minimum rate of return that management seeks from the project, IRR of te asset/project must be greater than the required rate of return, otherwise it will not be feasible for the management to accept the project. Best way to calculate IRR is using Excel.
Year
Cash flow
0
-7125000
1
1875000
2
1875000
3
1875000
4
1875000
5
1875000
6
1875000
7
1875000
8
1875000
IRR
20.33%
Formula
=IRR(J21:J31)
Project is accepted when IRR is more than the required rate of return ( 12%)
Since all the three capital budgeting techniques shows a positive result, so project should be accepted.
Year
Cash Inflow
PV factor
PV of cash flow
1
1875000
0.892857
1674107.143
2
1875000
0.797194
1494738.52
3
1875000
0.711780
1334587.965
4
1875000
0.635518
1191596.397
5
1875000
0.567427
1063925.354
6
1875000
0.506631
949933.3522
7
1875000
0.452349
848154.7788
8
1875000
0.403883
757281.0525
Total
9314324.563
Initial cost
7125000
NPV
2189324.563