FINA 395 Chapter Notes - Chapter 7: Payback Period, Ons Coding System, Net Present Value

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bronzespider550

25 Jan 2015

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Chapter 7: net present value and other investment rules. Cumulative cash flows year 1 = ,000 = ,000. Cumulative cash flows year 2 = ,000 +3,500 = ,500. Cumulative cash flows year 1 = ,500 = ,500. Cumulative cash flows year 2 = ,500 + 1,200 = ,700. Cumulative cash flows year 3 = ,500 + 1,200 + 3,000 = ,700. Companies can calculate a more precise value using fractional years. To calculate the fractional payback period, find the fraction of year 3"s cash flows that is needed for the company to have cumulative undiscounted cash flows of ,000. Divide the difference between the initial investment and the cumulative undiscounted cash flows as of year 2 by the undiscounted cash flow of year 3. Payback period = 2 + (,000 ,700) / ,000. Since project a has a shorter payback period than project b has, the company should choose project a. Discount each project"s cash flows at 15 percent.

Related Questions

Excel

Problem: The Drillago Company is involved in searching for locations in which to drill for oil. The firmâs current project requires an initial investment of $16.5 million and has an estimated life of 9 years. The expected future cash inflows for the project are as shown in the following table. All cash flows are expected to occur at the end of the year. The cost of capital is 11%.

Year	1	2	3	4	5	6	7	8	9
Cash slow	500,000	750,000	1,000,000	3,000,000	3,500,000	4,500,000	6,000,000	8,000,000	11,000,000

Create a spreadsheet to answer the following questions. Depict time in the columns, as shown above. Year: 1 2 3 4 5 6 7 8 9 Cash Inflo w 500,00 0 750,00 0 1,000,00 0 3,000,00 0 3,500,00 0 4,500,00 0 6,000,00 0 8,000,00 0 11,000,00 0

1. Calculate the projectâs NPV. Is the project acceptable under the NPV technique?

2. Calculate the projectâs IRR. Is the project acceptable under the IRR technique?

3. Did the NPV and IRR produce the same accept/reject results? Is there a preference for NPV or IRR?

4. Calculate the projectâs MIRR. How does it compare to the project IRR? Explain why the difference occurs.

5. Calculate the payback period for the project. If the firm usually accepts projects that have payback periods between 1 and 7 years, is this project acceptable? Note â you do not need to use an excel function for this answer. Instead, add an additional line to your spreadsheet and show the cumulative dollar return from the project for each year. From there, you can determine a rough idea of the payback period.

For example, the cumulative returns in the first few years are:

Year 1 = -$16.5m + $0.5 m = -$16.0m.

Year 2 = -$16.0m + $0.75m = -$15.25m

1) A company's 'bottom line' or net income increases. Which of the following statements is most correct?
A)The only possible cause is that sales increased.
B) The only possible cause is that expenses dropped.
C) Either sales increased, expenses decreased, or both may have happened
D) The only possible cause is that both sales must have increased and expenses must have decreased at the same time.

2) A project will cost $15,000 in total investment. The cash flows are as follows: Year 1: $5,000; Year 2: $3,000; Year 3: $6,000; Year 4: $8,000; Year 5: $7,000. Assume the cash flows are distributed evenly throughout the year. Calculate the exact payback period.
A) 4 Years B) 3 Years C) 3.50 Years D) 3.13 Years

bluebeaver63

QUESTION 6 [Total 29 marks]

A listed company has a proposed investment project where the expected cash flows are given in the table below. Market research into a feasibility study for the project was conducted at a cost of $5,000. The risk-free rate of return is given as 2% per annum. The yearly return for the Australian share market is given as 12%. Suppose the company has a beta value of 0.8.

Year 0 Project cash flow $(20,000)

Year 1 Project cash flow $(10,000)

Year 2 Project cash flow $(20,000)

Year 3 Project cash flow $(10,000)

Year 4 Project cash flow $(40,000)

Year 5 Project cash flow $(30,000)

(a) Determine the projectâs discount rate. (4 marks)

(b) Explain what is meant by sunk costs in capital budgeting. State the amount of any sunk costs for the project. (2 marks)

(d) If the maximum acceptable payback period for the project is 3 years, would the project be accepted? What are the disadvantages of the payback period method in making investment decisions? (5 marks)

(e) Explain the difference between the discounted payback period method and the payback period method. Would the project be accepted if the discounted payback period is used instead of the payback period? (5 marks) 5

(f) Explain whether the project would be accepted using the net present value (NPV) acceptance criterion. Explain why the NPV method is considered to be the best method in capital budgeting. (5 marks)

(g) Explain whether the project would be accepted using the profitability index (PI) acceptance criterion. (3 marks)

(h) Explain whether the project would be accepted using the internal rate of return (IRR) acceptance criterion. Explain why the IRR method is widely used in capital budgeting. (3 marks)

harlequincrab844

FINA 395 Chapter Notes - Chapter 7: Payback Period, Ons Coding System, Net Present Value

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