Assignment2_Answer

Assignment2_Answer - Assignment # 2 Answers Cost/Benefit,...

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(Chapter 4 - Olson) ISDS 4113 10. Given the following data, estimate payback, net present value, and cost/benefit ratio. Use a discount rate of 10% per year. Time Outflow Inflow Begin year 1 $10,000 $0 End year 1 $5,000 $6,000 End year 2 $3,000 $7,000 End year 3 $1,000 $8,000 Answer: First, we need to calculate the net cash flow for each year (Inflow – Outflow): Time Outflow Inflow Net Cashflow Begin year 1 $10,000 $0 (Initial investment) End year 1 $5,000 $6,000 $1,000 ($6,000 - $5,000) End year 2 $3,000 $7,000 $4,000 ($7,000 - $3,000) End year 3 $1,000 $8,000 $7,000 ($8,000 - $1,000) To calculate payback : Payback is the length of time (in years/months) it will take to recover your investment in the project. Since the “annual savings” (the positive net cashflow) is a different amount each year, we cannot use the simple formula shown in the slides (Payback period = Project Cost/Annual Savings). Instead, we need to look year-by-year to determine when the total savings = project cost ($10,000): o At the end of year 1, total savings = $1,000 o At the end of year 2, total savings = $5,000 ($1,000 + $4,000) o At the end of year 3, total savings = $12,000 ($1,000 + $4,000 + $7,000) This means that the “breakeven point” is somewhere during year 3. If we assume that the net cashflow was a steady amount during year 3 then the number of months to recover the remaining $5,000 of project costs during year 3 would be $5,000/$7000 = .7 years. So the estimated payback period is 2.7 years . 1
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Assignment2_Answer - Assignment # 2 Answers Cost/Benefit,...

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