Question

Assume the cost of capital for the firm for which you work is 10%. You are analyzing some projects with various capital budgeting techniques. You have decided a payback period of four years or better is acceptable.

Find the NPV for the project with the following cash flows and state whether the project is acceptable.

YR        Cash Flow

-$750,000

$250,000

$350,000

$375,000

Find the Payback Period and Discounted Payback Period for the project with the following cash flows and state whether the project is acceptable for either technique.

YR        Cash Flow

-$750,000

$135,000

$145,000

$155,000

$165,000

$175,000

Find the MIRR and IRR for the following project and state whether the project is acceptable under each technique:

YR        Cash Flow

-$100,000

$85,000

-$20,000

$74,400

Answer 1

Let me explain the Payback and discounted payback period.

Payback period is the number of years it would take undiscounted cash inflows to re-earn the invested amount whereas discounted payback is the number of years it would take discounted cash inflows to re-earn the invested amount.

For payback period above, till 4 years, company earns $600,000 and would need $150,000 more to re-earn invested amount of $750,000. But cash flow in year 5 is $175,000, which is higher than required. Fraction of year to earn $150,000 = ($175,000 - $150,000)/$175,000 = 0.86 year

Total payback = 4 + 0.86 years = 4.86 years

For discounted payback, the sum of all discounted cash flows is less than the re-invested amount. Hence, discounted payback can't be calculated.