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Homework answers / question archive / You are reviewing a new project

You are reviewing a new project

Finance

You are reviewing a new project. The required return for assets of this risk level is 12%. The estimated cash flows are: Year 0: CF = -165,000 Year 1: CF = 63,120; Net Income = 13,620 Year 2: CF = 70,800; Net Income = 3,300 Year 3: CF = 91,080; Net Income = 29,100 Average Book Value = 72,000 Assume we will accept the project if it pays back within two years and required AAR = 25% What is the payback period and the discounted payback period? What is the AAR? Should you accept or reject this project? o o

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Answer : Calculation of Payback Period :

Below is the table showing cash flows and cumulative cash flows:

Year Cashflows Cumulative Cash Flows
1 63120 63120
2 70800 133920
3 91080 225000

Payback Period = Complete years + (Initial Investment - Cash Flow recovered) / Cashflow for the year

= 2 + (165000 - 133920) / 91080

= 2.34 years

Discoounted Payback Perod :

Year Cash Inflows PVF @ 12% Present Value of Cash Inflow Cumulative Discounted Cash flows
1 63120 0.892857143 56357.14286 56357.14286
2 70800 0.797193878 56441.32653 112798.4694
3 91080 0.711780248 64828.94497 177627.4144

Discounted Payback Period = Complete years + (Initial Investment - Cash Flow recovered) / Cashflow for the year

= 2 + (165000 - 112798.4694) / 64828.94497

= 2.81 years

Calculation of AAR

AAR = Average Net Income / Average Book value

= [(13620 + 3300 + 29100) / 3] / 72000

= 15340 / 72000

= 21.31%

Since Payaback Period and AAR both are not within the acceptable limit therefore Reject the project.

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