Question

The directors of Delta Co are considering a planned investment project costing $28m, payable immediately. The following information relates to the investment project:

Years	1	2	3	4
Project Cash flow	10,168	11,585	12,682	14,894

The views of the directors of Delta Co are that all investment projects must be evaluated over four years of operations. Both net present value and payback must be used, with a maximum payback period of two years. The after-tax cost of capital of Delta Co is 12%.

Required:

1. Calculate the net present value of the planned investment project.
2. Calculate the payback period of the planned investment project.
3. Discuss the financial acceptability of the investment project.
4. State clearly any limitations and assumptions that you made in your calculations.

Answer 1

a) NPV of the project = Value of the discounted cash flows at a fiscount rate of 12%

Using financial calculator -

CF0 = -28m

CF1 = 10.168m

CF2 = 11.585m

CF3 = 12.682m

CF4 = 14.894m

I = 12%

NPV = $9.464m

b) Payback period = It means the time to recoup the investment

First year cash flow = $10.168m

Second year cash flow = $11.585m

Third year cash flow = $12.682m

Payback period = 2 years + $6.247/$12.682m, as 3 year cash flow exceeding the investment

Payback period = 2 + 0.492 = 2.492

Payback period = 2.5 years approx

c) Project has positive NPV.So, the company can accept the investment in this project. However, the investment has a payback period of 2.5 years which is higher than mentioned limit of 2 years. On the basis of Payback period, project can't be accepted

d) We have considered cash flows are in ('000s). It means $10,168,000 or $10.168m