Question

Payback, NPV, and IRR: Rieger International is evaluating the feasibility of investing

$96,000 in a piece of equipment that has a 5-year life. The firm has estimated the cash inflows associated with the proposal as shown in the following table: The firm has a 8% cost of capital.

a. Calculate the payback period for the proposed investment.

b. Calculate the net present value (NPV) for the proposed investment.

c. Calculate the internal rate of return (IRR), rounded to the nearest whole percent, for the proposed investment.

d. Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project?

year cash inflows

1 35,000

2 30,000

3 30,000

4 35,000

5 30,000

Answer #1

**A)** Payback period is the period in which we get
back the invested amount

1st year = 35,000 (Cumulative = 35,000)

2nd year = 30,000 (Cumulative = 65,000)

3rd year = 30,000 (Cumulative = 95,000)

4th year = 35,000 {35,000 : 1 year :: 1,000 : (1/35)} = 0.0285

**Payback period = 3.0285 Years**

**B)** NPV = Present value of cash inflows -
Present value of cash outflow

= {(35,000/(1+8%)1) + (30,000/(1+8%)2) + ..... + (30,000/(1+8%)5)} - 96,000

= $128,086 - $96,000 = **$32,086**

**C)** IRR gives the internal rate of return by
equating:

Present value of cash inflow = Present value of cash outflow {and replacing rate of return (8%) by IRR}

96,000 = 35,000/(1+IRR)1 + 30,000/(1+IRR)2 + ... + 30,000/(1+IRR)5

Solving this, we get **IRR = 20%**

**D)** As the project has positive NPV and IRR
(20%) greater than cost of capital (8%), the project should be
**accepted.**

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