1.
An investment project provides cash inflows of $840 per year for eight years
To calculate the payback period, we need to find the time that the project has recovered its initial investment. The
cash flows in this problem are an annuity, so the calculation is simpler. If the initial cost is $3,000, the payback
period is:
Payback = 3 + ($480 / $840) = 3.57 years
There is a shortcut to calculate the payback period if the future cash flows are an annuity. Just divide the initial cost
by the annual cash flow. For the $3,000 cost, the payback period is:
Payback = $3,000 / $840 = 3.57 years
For an initial cost of $5,000, the payback period is:
Payback = 5 + ($800 / $840) = 5.95 years
The payback period for an initial cost of $7,000 is a little trickier. Notice that the total cash inflows after eight years
will be:
Total cash inflows = 8($840) = $6,720
If the initial cost is $7,000, the project never pays back. Notice that if you use the shortcut for annuity cash flows, you
get:
Payback = $7,000 / $840 = 8.33 years.
This answer does not make sense since the cash flows stop after eight years, so the payback period is never.
2.
Teddy Bear Planet, Inc., has a project with the following cash flows.
YEAR
CASH FLOWS
0
$
–8,000
1
4,000
2
3,000
3
2,000
Required:
(a)
What is the IRR of the Project?
(Input answer as a percent rounded to 2 decimal places, without the
percent sign. For example 3.16)
Teddy Bear Planet, Inc., has a project with the following cash flows.
YEAR
CASH FLOWS
0
$
–8,000
1
4,000
2
3,000
3
2,000
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View Full DocumentRequired:
(a)
What is the IRR of the Project?
(Input answer as a percent rounded to 2 decimal places, without the
percent sign. For example 3.16)
IRR= 6.93
3.
Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation
(BRC). Both projects require an annual return of 15 percent.
Year
DEEPWATER
FISHING
NEW SUBMARINE
RIDE
0
–$ 600,000
–$ 1,800,000
1
270,000
1,000,000
2
350,000
700,000
3
300,000
900,000
As a financial analyst for BRC, you are asked the following questions.
Requirement 1:
(a)
Calculate the IRR for Deepwater Fishing and New Submarine Ride.
(Input answer as a percent rounded
to 2 decimal places, without the percent sign.
The IRR is the interest rate that makes the NPV of the project equal to zero. So, the IRR for each
project is:
Deepwater Fishing IRR:
0 = C
0
+ C
1
/ (1 + IRR) + C
2
/ (1 + IRR)
2
+ C
3
/ (1 + IRR)
3
0 = –$600,000 + $270,000 / (1 + IRR) + $350,000 / (1 + IRR)
2
+ $300,000 / (1 + IRR)
3
Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find
that:
IRR = 24.30%
Submarine Ride IRR:
0 = C
0
+ C
1
/ (1 + IRR) + C
2
/ (1 + IRR)
2
+ C
3
/ (1 + IRR)
3
0 = –$1,800,000 + $1,000,000 / (1 + IRR) + $700,000 / (1 + IRR)
2
+ $900,000 / (1 + IRR)
3
Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find
that:
IRR = 21.46%
Based on the IRR rule, the deepwater fishing project should be chosen because it has the higher
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 Spring '09
 N/A
 Finance, Depreciation, Annuity, Net Present Value, Internal rate of return

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