Question

Ella, Inc. is considering a new capital budgeting project (the “Investment”). The Investment will cost $102,030 that must be invested today, and $105,000 that must be invested at the end of year one. The Investment will have the following net cash inflows at the end of each of the next three years. Year 1: $50,000; Year 2: $75,000; and Year 3: $100,000. The financial accounting net operating income for each of the next three years is as follows: Year 1: $25,000; Year 2: $50,000; and Year 3: $75,000. Assume all cash flows, except for the initial investment, occur at the end of the year. Ella’s cost of capital (discount rate) is 5% per year.

Use the formula (or a financial calculator) to calculate the present value of $1, and not the factors as shown in the table in Chapter 25 of your text, which do not show the factors for 5%.   For instance, the factor for the present value of $1 at the end of one period at 5% is calculated as: 1 / (1+.05) 1, which equals 0.952381.   At 5%, for period two the factor is 0.907029, and for period 3 the factor is 0.863838. Please show ALL your work.

a. What is the Payback Period?

b. What is the Present Value of the Investment’s Cash Outflows?  

c. What is the Net Present Value of the Investment?  

d. What is the Investment’s Internal Rate of Return?

e. Should Ella, Inc. invest? Explain why or why not?

Answer 1