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# HWM2A08 - 1 An investment project provides cash inflows of...

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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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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) 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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HWM2A08 - 1 An investment project provides cash inflows of...

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