Question

Case Analysis 1: You work for a small, local telecommunications company. In five years, the company plans to undertake a major upgrade to its servers and other IT infrastructure. Management estimates that it will need up to $450,000 to cover all related costs; however, as a fairly young company, the goal is to pay for the upgrade with cash and not to take out loans. Right now, you have $300,000 in a bank account established for Capital Investments. This account pays 4% interest, compounded annually. A member of the finance department has approached you with an investment opportunity for the $300,000 that covers a five-year period and has the following projected after-tax cash flows:

Year Projected Cash Flow

1 $90,000

2 $115,000

3 $135,000

4 $110,000

5 $90,000

Based on this information, in an MS Word document, answer the following questions:

1) How much money will be in the bank account if you leave the $300,000 alone (earning 4% compounded interest) until you need it in five years?

2) If you undertake the investment opportunity, what is the Nominal Payback Period?

3) Using the Present Value factors for 7% (which can be found on any PV Factor table), what is the discounted Payback Period of the investment opportunity?

4) What is the Net Present Value at 7% of the investment opportunity?

5) Which option (make the investment or leave the money in a savings account) would you recommend to your CEO? Why? What additional factors/information might make you change your point of view?

Answer 1

As per rules I will answer the first 4 subparts of the question

1)Amount after 5 years= P*(1+r)^n

=300000*1.04^5

=$364995.87

2.Cumulative cash flow in 2 years = 90000+115000 = 205000

Nominal payback = 2 years + (Initial investment-Cumulative cash flow)/ CF in year 3

=(300000-205000)/135000

= 2.7 years

3. The discounted cash flows will be as under

Year	Cash flow	PV of cash flow	Cumulative cash flow
1	90000	84112.14953	84112.14953
2	115000	100445.4538	184557.6033
3	135000	110200.2134	294757.8167
4	110000	83918.47333	378676.29
5	90000	64168.75615	442845.0461

Discounted payback= 3 years + (300000-294757.82)/

378676.29

= 3.0138 years

4. NPV= Sum of discounted cash flows- Initial cash flow

442845.0461- 300000

=142845.0461

WORKINGS