Question

Answer 13, 14, and 15 using the following information:
Jane plans to open a new business. The equipment will cost $175,000. Jane expects the after-tax cash inflows to be $65,000 annually for 5 years, after which she plans to scrap the equipment and retire to the beaches of Jamaica.

13. What is the project's payback period?

1. A) 2.69 years

2. B) 3.33 years

3. C) 3.67 years

4. D) 4.33 years

5. E) 5.67 years

14. Assume the required return is 17%. What is the project's NPV?

1. A) $887

2. B) $13,322

3. C) $22,759

4. D) $32,957.50

5. E) $80,023.89

15. Assume the required return is 26%. What is the project's IRR? Should it be accepted?

1. A) 14.95%; yes

2. B) 26%; yes

3. C) 27.95%; yes

4. D) 28%; yes

5. E) None of the above

Answer 1

a.

Payback Period (when cash inflow is equal) = Cost / Cash inflow

= 175000 / 65000 = 2.69 year Answer

b.

NPV = Present value of future cash inflow - cash outlay

Rate = 17%

NPV = 65000/(1+0.17)^1 + 65000/(1+0.17)^2 + 65000/(1+0.17)^3 + 65000/(1+0.17)^4 + 65000/(1+0.17)^5 - 175000

NPV = 32957.50 Answer

The option D is correct.

c.

IRR is the rate for which NPV of a project equals 0.

0 = 65000/(1+IRR)^1 + 65000/(1+ IRR)^2 + 65000/(1+IRR)^3 + 65000/(1+ IRR)^4 + 65000/(1+ IRR)^5 - 175000

We will use heat and trial method to get that value for which above equation satisfy.

IRR = 24.95% Answer

OR Using Financial Calculator:

N = 5

PV = 0

PMT = -65000

PV = 175000

CPT I/Y

IRR = 24.95% Answer

Required Return = 26%

According to IRR rule, a project can only be accepted if required return < IRR.

Hence it should not be accepted.

Option E is correct.

answered by: anonymous