Students must analyze a capital project based on the criteria below and determin
ID: 2805071 • Letter: S
Question
Students must analyze a capital project based on the criteria below and determine whether to undertake the project. The problems must be submitted to the Drop Box by Monday at midnight. There is no time limit for the short problems like the Multiple Choice Problems, so you have all week to complete them. Remember to provide the backup work so I have the ability to give partial credit.
You are evaluating a project based on the following:
Initial Investment: $2,750,000
Cash Flows: $500,000 per year for 7 years (end of year)
Required Return: 7%
Required Payback: 6 Years
1. Would you accept or reject the project based on the Net Present Value (NPV)?
2. Would you accept or reject the project based on the Payback Period?
3. Would you accept or reject the project based on the Discounted Payback Period?
4. Based on your answers to Questions 1-3, would you accept or reject the project? Why?
Explanation / Answer
Answer 1 Calculation of Net Present value of project NPV = Present value of future cash inflow - Initial Investment in project Present value of future cash inflow = Cash inflow per year * Present value Annuity factor @ 7% for 7 years Present value Annuity factor @ 7% for 7 years = [1-(1+r)^-n]/r = [1-(1+0.07)^-7]/0.07 = 5.389289 Present value of future cash inflow = $500000 * 5.389289 = $26,94,644.70 NPV = $26,94,644.70 - $27,50,000 = -$55,355.70 I would reject the project based on NPV as NPV is negative. Answer 2 Calculation of payback period Pay back period = Initial Investment / Yearly Cash flow = $27,50,000 / $500000 = 5.50 years I would accept the project based on pay back period as pay back period is lower than required payback period. Answer 3 I would reject the project based on discounted payback period as the project is unable to cover the entire initial investment within project period. Answer 4 Based on answers to questions 1-3 , I would reject the project as it has negative NPV and discounted cash flows unable to recover the entire initial investment within project period.The payback period doesn't consider the time value of money,hence we can't depend on this method only to decide about the project.