Question

b) The directors of Chiyeyeye are looking at purchasing a machine that with generate the following income of ZMW 1000 in year 1, ZMW 2000 in year 2, ZMW 3000 in year 3, ZMW 4000 in year 4 and ZMW 6000 in year 5. The cost of the machinery ZMW 12000 which will be depreciated straight line to zero over the five year life of the project. The cost of capital is 12% (i) What is The NPV? (ii) What is the payback period? c) Based on NPV, should the directors of Chiyeyeye purchase the machinery?

Answer 1

We will discount the given cash flows at 12% rate to find the NPV

Year	Cash flow	Cumulative cash flow
0	ZMW -12000
1	ZMW 1000	ZMW 1000
2	ZMW 2000	ZMW 3000
3	ZMW 3000	ZMW 6000
4	ZMW 4000	ZMW 10000
5	ZMW 6000	ZMW 16000

NPV = -12000 + 1000/(1.12) + 2000/(1.12)^2 + 3000/(1.12)^3 + 4000/(1.12)^4 + 6000/(1.12)^5 (all figures in ZMW)

i) NPV = ZMW -1430.78

ii) The payback period is = 4 years + 2000/6000

= 4.33 years

iii) as the NPV is negative, the director of Chiyeyeye should not purchase the machinery.

Let me know in the comment section in case of any doubt.