Question

Porter is deciding on an investment proposal. Look at the chart below to calculate the problems below.  All cash flows are assumed to take place at the end of the year. The salvage value of the investment at the end of each year is equal to its book value. There would be no salvage value at the end of the investment’s life.

Investment Proposal
Year		Initial Cost and Book Value			Annual Cash Flows			Annual Net Income
0		$105,800
1		69,800			$46,000			$10,000
2		42,200			39,400			11,800
3		21,800			34,300			13,900
4		6,300			29,300			13,800
5		0			24,000			17,700

Porter uses an 11% target rate of return for new investment proposals.

(a)

What is the cash payback period for this proposal?

(b)

What is the annual rate of return for the investment?

(c)

What is the net present value of the investment?

Answer 1

a) Cash Payback period is the no. of years it takes to recover the initial investment, which we can observe happens in year 3.

Cash Payback = 2 + (105,800 - 46,000 - 39,400) / 34,300 = 2.59 years

b) Annual Rate of return can be calculated using IRR function on a calculator

Insert CF0 = -105,800, CF1 = 46,000....CF5 = 24,000

=> Compute IRR = 21.69%

c) NPV similarly can be calculated using NPV function on a calculator

With the above cash flows, insert, I/Y = 11%

=> Compute NPV = $26,242.88