Question

Calculate the Net Present Value and Pay-Back Period for the below investment (please show calculations):  

Rate of return: 15%

Inflation rate: 2%

Investment:

Year	Investment Cost	Recurring Cost	Revenue
1	$5,000,000
1		$100,000	$3,500,000
2		$125,000	$3,500,000
3		$325,000	$2,500,000
4		$325,000	$2,000,000
5		$500,000	$1,250,000

Answer 1

Solution: We will use real discount rate with real cash flows method to compute net present value:

Real rate of return = (1+r)/(1+i) - 1 = (1.15 / 1.02 ) - 1 = 12.75%

Computation of Net present value:

Computation of payback period:

As per above cumulative cash inflows, initial investment cost is recovered 1 to 2 year because $5,000,000 of initial investment is between $3.4million & $6.775million.

Thus, Payback period = 1 + (5,000,000-3,400,000)/3,375,000

= 1 + 0.47 = 1.47 year