Question

Blackmores company is evaluating the feasibility of investing $80000 in a project with a 5 years life. The firm has estimated the cash inflows associated with the proposal as shown in the following table. The firm’s cost of capital is 8%. Company’s policy to recoup investment is four years or less. Average book value is $13550

Year	cash inflows	Net income
1	$25000	$3000
2	$25000	$2500
3	$25000	$2250
4	$25000	$2600
5	$25000	$3200

Require:

a. Calculate the NPV (Net Present Value), Payback Period, profitability Index and AAR ( Average Accounting Return) for the proposed investment

b. Should Blackmores company accept or reject the proposed investment

Answer 1

a)	Year	Cash inflows	PVIFA at 8%	PV at 8%
	1	25000	0.92593	23148
	2	25000	0.85734	21433
	3	25000	0.79383	19846
	4	25000	0.73503	18376
	5	25000	0.68058	17015
				99818
	NPV = PV of cash inflows-Initial investment = 99818-80000 = $19,818
	Profitability index = PV of cash inflows/Initial investment = 99818/80000 = 1.25
	Payback period = initital investment]Annual cash inflow = 80000/25000 = 3.2 years
	Year	Net income
	1	3000
	2	2500
	3	2250
	4	2600
	5	3200
		13550
	ARR = Average net income/Average investment = (13550/5)/13550 = 20%
b)	The company should accept the project, because
	*the NPV is positive, because of which PI is >1.
	*payback period is less than the maximum 4 years prescribed.
	*ARR is greater than 8%.