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:
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
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