Question
A company is considering investing in a new project that requires an initial investment of $200,000. The project is expected to generate cash flows of
A company is considering investing in a new project that requires an initial investment of $200,000. The project is expected to generate cash flows of $60,000 at the end of year 1, $80,000 at the end of year 2, and $120,000 at the end of year 3. The company's cost of capital is 10%. Calculate the following:
a) Net Present Value (NPV) of the project. b) Profitability Index (PI) of the project. c) Discounted Payback Period of the project.
Step by Step Solution
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The detailed answer for the above question is provided below a To calculate the Net Present Value NPV of the project we need to discount the cash flows by the discount rate and then subtract the initial investment The formula for NPV is NPV CF1 1r1 CF2 1r2 CFn 1rn Initial Investment Where CF Cash Flow r Discount rate n Number of years Initial Investment 200000 The cash flows for the next 3 years are given as 60000 80000 and 120000 respectively Thus the NPV of the project can be calculated as NPV 60000 1011 80000 1012 120000 1013 200000 NPV 4252632 Therefore the Net Present Value of the project is 4252632 b The Profitability Index PI of the project is the ratio of the present value of the cash inflows to the initial investment We can calculate the PI as follows PI Present value of cash inflows Initial Investment The present value of cash inflows can be calculated as PV of CF1 60000 1011 5454545 PV of CF2 80000 1012 6198347 PV of CF3 120000 1013 9272727 Present value of cash inflows 5454545 6198347 9272727 20925619 Thus the PI of the project can be calculated as PI 20925619 200000 PI 10463 Therefore the Profitability Index of the project is 10463 c The Discounted Payback Period of the project is the time it takes for the present value of the cash inflows to equal the initial investment We can calculate the Discounted Payback Period as follows PV of CF1 5454545 PV of CF2 6198347 PV of CF3 9272727 At the end of year 2 the present value of the cash inflows is 11652892 The remaining amount needed to reach the initial investment is Remaining amount 200000 11652892 Remaining amount 8347108 We can then calculate the payback period for the remaining amount using the PV of the next cash flow ...
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Principles of managerial finance
Authors: Lawrence J Gitman, Chad J Zutter
12th edition
9780321524133, 132479540, 321524136, 978-0132479547
