Question

Gallore Ltd is evaluating whether they should invest in a new machine for their
production line. The purchase price is estimated to be $109,000. It will have a 3 year
life with a zero salvage value. The project will produce the following cash inflows:
Yr 1 - $56,000
Yr 2 - $75,000
Yr 3 - $48,000
The required return is 10% pa
1- Use payback period and NPV capital budgeting techniques to evaluate the
above project.
2- Explain why Gallore should or should not proceed with the project.

Answer 1

Payback period is the time required in order to generate future cashflows which equals cost of project.

Cost of project = 109000

Year	Cashflow	Cumulative Cashflow	Time Utilized
1	56000	56000	1
2	75000	56000 +53000 =109000	53000/75000 = 0.71
3	48000

For 2nd year only 53000 of cashflow is required to make future cashflow equals cost of project.

Time required = 53000 /75000 = 0.71

Payback Period = 1 +0 .71 = 1.71 years Answer

NPV = Present Value of future cashflow - initial cost

Required Return = 10%

NPV = 56000/(1+0.1)^1 + 75000/(1+0.1)^2 + 48000/(1+0.1)^3 - 109000

NPV = $39955.67 Answer

Gallore should proceed with the project as NPV of the project is greater than 0.

A positive NPV shows that the project will deliver the value.